le  LIBRARY 


EAR  L 
READE 

OBERN 


UCSB   LiBKART 


LIBRARY"  ^-— 

THE  UNIVERSITY 
OF  CALIFORNIA 

SANTA  BARBARA 


PRESENTED  BY 

GEORGE  OBERN 


XVIII— 1 
K-3-T 


Modern  Business 

A  Series  of  Texts 
prepared  as  part  of  the 

Modern  Business  Course  and  Service 


Registered  Trade  Mark 

United  States  and  Great  Britain 

Marca  Registrada,  M.  de  F. 


Alexander  Hamilton  Institute 


Modern  Business  Texts 

Prepared  as  part  of  the 

Modern  Business  Course  and  Service 


1. 

Business  and  the  Man 

14. 

Corporation  Finance 

2. 

Economics 

15. 

Transportation 

The  Science  of  Business 

16. 

Foreign  Trade  and 

3. 

Business  Organization 

Shipping 

4. 

Plant  Management 

17. 

Banking 

5. 

Marketing  and 

18. 

International  Exchange 

Merchandising 

19. 

Insurance 

6. 

Salesmanship  and  Sales 

20. 

The  Stock  and  Produce 

Management 

Exchanges 

7. 

Advertising  Principles 

21. 

Accounting  Practice  and 

8. 

Oflfice  Administration 

Auditing 

9. 

Accounting  Principles 

22. 

Financial  and  Business 

10. 

Credit  and  Collections 

Statements 

11. 

Business  Correspondence 

23. 

Investments 

12. 

Cost  Finding 

24. 

Business  and  the 

• 

13. 

Advertising  Campaigns 

Government 

EDITOR-IN-CHIEF 

JOSEPH  FRENCH  JOHNSON 

EDITORS,'  WRITERS   AVW   CONSULTANTS 

[  See  list  on  page  V  of  Volume  1  ] 


International  Exchange 


By  Alexander  Hamilton  Institute 
in  coUaboration  with 

E.  L.  Stewart  Patterson 

Superintendent,  Eastern  Townships  Branches 
Canadian  Bank  of  Commerce 


Modern  Business  Texts 

Volume  18 


Alexander  Hamilton  Institute 
New  York 


Copyright,  1921,  by  Alexander  Hamilton  Institute 

Copyright  in  Great  Britain,  1921,  by  Alexander  Hamilton  Institute 

All  rights  reserved,  including  translation  into  Scandinavian 

Latest  Revision,  1922 

Made  in  U.  S.  A. 


PREFACE 

International  exchanges  have  an  unusual  interest 
at  the  present  time,  and  there  is  much  confusion  of 
thought  in  regard  to  the  influences  which  fix  exchange 
rates.  They  are  in  a  highly  sensitive  state  and  like  a 
person  with  shattered  nerves  react  somewhat  violently 
to  changes  in  external  conditions.  This  obscures  to 
the  onlooker  the  working  of  the  fundamental  princi- 
ples which  govern  international  payments.  An  ex- 
amination of  the  seemingly  mysterious  but  in  reality 
simple  underlying  principles  of  international  ex- 
change should  prove  interesting  not  only  to  the 
exporter  and  the  importer,  but  to  business  men  in 
general  who  are  concerned  in  watching  the  factors 
which  make  for  a  nation's  welfare. 

It  would  be  impossible  to  understand  exchange  in 
its  present  dislocated  and  abnormal  state  without  a 
thoro  knowledge  of  its  operation  under  normal  condi- 
tions, and  for  this  reason  the  basic  principles  which 
govern  exchange  under  the  latter  have  been  fully  ex- 
plained, altho  reference  to  the  more  important  factors 
which  influence  the  exchanges  today  has  been  fre- 
quently made. 

In  preparing  the  present  volume,  we  have  drawn 
largely  upon  the  material  furnished  by  Mr.  E.  L. 


vi  PREFACE 

Stewart  Patterson,  Superintendent  of  Eastern  Town- 
ships Branches  of  the  Canadian  Bank  of  Commerce, 
to  whose  ripe  experience  and  profound  knowledge 
of  the  subject  of  international  exchange  the  greater 
part  of  the  work  is  due. 

Joseph  French  Johnson. 


TABLE  OF  CONTENTS 
CHAPTER  I. 

THE   EXCHANGE    SITUATION   TODAY 

SECTIOM  PAGE 

1 .  The  Established  Order  Crumbles 1 

2.  International  Exchange  and  Civilization       .      .  1 

3 .  Interest  of  the  Unusual 2 

4.  Fluctuating    Standards,  National    and    Inter- 

national       3 

5 .  Normal  Exchange  Relations 4 

6.  Internal  Change  Wrought  by  War     ....  5 

7.  Monetary  Disturbance 6 

8.  External  Relations  in  Wartime     .....  7 

9.  Exchange  Before  the  War 8 

10.  Present  Exchange  Situation 9 

11.  Plan  of  Discussion 10 

CHAPTER  II. 


FUNDAMENTALS    OF   EXCHANGE 

1 .  Clearing  Process  in  Exchange 

2.  Settlement  of  Equal  Debts 

3.  Settlement  of  Unequal  Debts 

4 .  The  Dealer  in  Exchange 

5 .  The  Exchange  Rate 

6.  Exchange  at  a  Discount 

7.  The  Exchange  Market 

8.  Exchange  Centers    . 

9.  Gold  Points        .      .      . 
10.  Demand  and  Supply     . 


12 
12 
13 
13 
14 
15 
16 
17 
18 
18 


viii  INTERNATIONAL  EXCHANGE 

SECTION  PAGE 

11.  Exchange  as  a  Trade  Factor 19 

12.  The  Role  that  Money  Plays 21 

13.  Exchange  with  Foreign  Centers 22 

14 .  Countries  Using  the  Same  Money      ....  23 

15.  Countries  Using  Different  Coinages  ....  25 

16.  Countries  with  Different  Money  Standards        .  25 

CHAPTER  III. 

INTERNATIONAL   PAYMENTS ORIGIN 

1.  How    Indebtedness    Between    Two    Countries 

Arises 27 

2 .  Interdependence  of  Exports  and  Imports     .      .  28 

3.  Origin  and  Supply  of  Foreign  Exchange       .      .  30 

4 .  "The  United  States  in  Account  with  the  World"  33 

5.  Significance  of  the  Elements  in  the  Balance     .  .  36 

CHAPTER  IV. 

GOLD    EXCHANGE   RATES 

1.  Gold  Standard 39 

2.  Gold  Exchange  Standard 40 

3.  Monetary  Systems    ' 40 

4 .  Mint  Par  of  Exchange 42 

5.  Par  of  Exchange 44 

6.  Rates  of  Exchange 45 

7.  What  Makes  the  Rate 46 

8.  Coinage  Ratio 47 

9.  Fluctuation  in  the  Rate  of  Exchange       ...  47 

10.  Rates  Tend  to  Correspond 48 

11.  Gold  Points 49 

12.  Significance  of  Gold  Movements        .      .      .      .51 

13.  Actual  Gold  Points 51 

14.  Computing  the  Gold  Point 52 


CONTENTS  ix 

SECTION  PAGE 

15.  Gold  Shipments  from  New  .York        ....  53 

16.  Avoiding  Gold  Shipments 55 

17.  Reading  the  Exchange  Rates        .      .      .      .      .55 

18.  Exchange  Quotations 56 

19.  Range  of  Quotations 58 

20.  Fixed  and  Movable  Exchange 59 

21.  Premium  and  Discount 61 

22.  Exchange  Tables 62 


CHAPTER  V. 

EXPORTS   AND    IMPORTS 

1 .  Payments  for  Exports 65 

2.  The  Place  of  the  Transaction 67 

3.  Financing  Foreign  Exports  by  Means  of  Dollar 

Credits 69 

4.  Dollar  Acceptances 71 

5 .  Export  Letters  of  Credit    .  * 75 

6.  Commercial  Letters  of  Credit  and  Importing  77 

7.  British  Acceptances  Lender  Letters  of  Credit      .  78 

8.  History  of  the  Draft  in  London 80 

9.  Position  of  the  Obligants  on  the  Bill  .      .81 

10.  The  Part  London  Plays 82 

11.  Dollar  Exchange 84 

12.  Exports  and  Imports  are  Complementary    .  85 

CHAPTER  VI. 

INVESTMENT   AND   ARBITRAGE 

1.  International  Finance 90 

2.  Investments 90 

3.  Foreign  Investments  in  the  United  States    .  93 

4.  United  States  a  Creditor  Nation        ....  94 

5.  International  Securities 95 


X  INTERNATIONAL  EXCHANGE 

SECTION  PAGE 

6.  TMiat  is  Arbitrage? 96 

7.  When  Arbitrage  is  Transacted 96 

8.  Parity 97 

9.  Parity  in  Stocks 99 

10.  Chain  Rule 100 

11.  Simple  Arbitrage 101 

12.  Compound  Arbitrage 103 

13.  Arbitrage  in  Gold 105 


CHAPTER  VII. 

FINANCE   BILLS 

1.  Definition  of  a  Finance  Bill 108 

2.  Finance  Bill  for  New  York  Account        .      .      .  109 

3.  Method  of  Using  Finance  Bills 110 

4.  Loan  of  a  Finance  Bill 112 

5.  A  Finance  Bill  on  London  Account    .      .      .      .113 

6.  Other  Uses  of  Finance  Bills 114 

7.  Forward  Exchange 115 


CHAPTER  VIII; 

RATES    OF   INTEREST 

1.  Interest    an    Important    Factor    in    Exchange 

Quotations 119 

2.  Long  Bills 119 

3.  Bank  Rate 120 

4.  Market  Rate 121 

5.  Retirement  Rate 122 

6.  Importance  of  the  Bank  of  England  Rate    .      .  122 

7.  What  the  Bank  of  England  Rate  Effects      .      .  124 


CONTENTS  xi 
CHAPTER  IX. 

BILLS    OF    EXCHANGE 

SECTION  PAGE 

1.  Bills  of  Exchange 127 

2.  Sight  Drafts :      ....  128 

3.  Cable  Transfers 132 

4.  Unusual  Rates  for  Cables 133 

5.  Long  Exchange 134 

6.  Influence  of  the  Interest  Rate 136 

7.  Commercial  Long  Bills 138 

8.  Bankers' Long  Bills 139 

9.  Bills  of  Exchange  That  Involve  More  or  Less 

Risk 139 

10.     Letters  of  Credit 144 

CHAPTER  X. 

FOREIGN  REMITTANCES 

1 .  Non-Commercial  Exchange 147 

2.  Principles  Underlying  the  Issuance  of  Drafts     .  148 

3.  Advices 150 

4.  Specimen  Forms  and  Signatures 152 

5.  Cost  of  Drafts  to  Purchasers 152 

6.  Travelers'  Checks 153 

7.  Payment  of  Checks 154 

8.  Payment  to  Holders 154 

9.  Redemption  of  Checks 157 

10.  Letter  of  Indication 158 

11.  Lost  Travelers' Checks 159 

12.  Letters  of  Credit 160 

13.  Payment  to  the  Holder 167 

14.  Circular  Notes 168 

15.  Foreign  Money  Orders 168 

16.  Payment  of  Orders 171 

17.  Mail  Remittances 172 


xii  IXTERNATIOXAL  EXCHANGE 

CHAPTER  XI. 

THE    SILVER    STANDARD 

SECTION  PAGE 

1.  Silver  Standard 175 

2.  Silver  Mint  Par 176 

3.  No  Mint  Par  Between  Countries  on  Different 

Standards 177 

4.  Exchanges  between  Gold  and  Silver  Countries  .  177 

5.  Gold  Prices  of  Silver 178 

6.  Real  Situation  as  to  Silver 179 

7.  Silver  and  International  Exchange     ....  18:2 

8.  Asia's  Historic  Influence 184 

9.  How  Silver  is  Marketed .185 

10.  The  Silver  Price  Flurry 187 

11.  Effects  on  Eastern  Exchange 188 

12.  Silver  Melting  Points 189 

13.  Silver  Standard 191 

14.  Eastern  Exchange 193 

15.  Currency  of  China 193 

16.  Chinese  Exchanges 195 

CHAPTER  XII. 

FIAT    OR   IRREDEEMABLE   PAPER   MONEY 

1.  Money  and  the  War 197 

2.  Trade  on  a  Paper  Basis 199 

3.  Fruits  of  War 202 

4 .  Current  Exchange  Rates 203 

5.  Paper  Currencies 204 

6.  Paper  Money  as  a  Standard 205 

7.  Results  of  Depreciation 206 

8.  ChiJe 217 


CONTENTS  xiii 


CHAPTER  XIII. 

NEW   YORK   AND    LONDON   AS    FINANCIAL   CENTERS 

SECTION  PAGE 

1.  New  York's  Prominence  in  World  Finance  .      .   212 

2.  What  Makes  a  Financial  Center 212 

3.  Finance  Follows  Trade 213 

4.  World  Exchange  Must  Mean  Gold    .      .      .      .215 

5.  Liquid  Discount  Market 216 

6.  New  York's  Advantages 217 

7.  Physical  Conditions  Favorable  to  London    .      .219 

8.  Mail  and  Cable  Facihties 220 

9.  Time  Advantages 220 

10.  National  Characteristics 221 

11.  Willingness  to  Seek  Fortune  Abroad        .      .      .   222 

12.  London's  Discount  Market 223 


CHAPTER  XIV 

RESTORATION    PROSPECTS    FOR    EXCHANGE 

1.  Existing  Conditions 225 

2.  The  Position  of  New  York  and  of  London   .      .   227 

3.  Reasons  for  Disorganization 229 

4.  Spending  More  than  National  Income    .      .      .   229 

5.  Inflation 230 

6.  Loss  of  Means  of  Production 232 

7.  Disorganization  of  Working  Forces    ....   233 

8.  Commercial  Parity 234 

9.  The  Sensitive  Condition  of  Exchange      .      .      .236 

10.  Financial  Reconstruction  and  its  Effects      .      .237 

11.  Exportation  of  Capital 238 

12.  Efforts  for  Concerted  Action 240 


xiv  INTERNATIONAL  EXCHANGE 

SECTION  PAGE 

13.  International  and  National  Issues      .      .      .      .241 

14.  National  Duty 242 

15.  DiflSculties  in  Extending  Credit 242 

16.  Need  of  Increased  Production 244 


APPENDIX 

A  The  Brussels  Conference 246 

B  Domestic  Exchange 261 


INTERNATIONAL 
EXCHANGE 

CHAPTER  I 

THE  EXCHANGE  SITUATION   OF  TODAY 

1.  The  established  order  crumbles. — "In  August, 
1914,"  says  Hartley  Withers,  "civilization  went  into 
the  hands  of  a  receiver,  the  God  of  Battles."  His  grip 
on  the  destinies  of  mankind  has  been  broken  but  not 
entirely  shaken  off.  What  has  been  rescued  from  his 
grim  hands  is  frayed  and  tattered,  and  the  patient  la- 
bor of  many  years  will  be  required  to  repair  the  rav- 
ages of  war  and  bring  the  affairs  of  the  world,  both 
political  and  economic,  to  an  orderly  basis. 

No  nation  of  the  world,  whether  a  belligerent  or 
not,  has  failed  to  feel  in  some  degree  the  consequences 
of  the  World  struggle.  Into  every  nook  and  corner 
of  our  business  life  its  destructive  fingers  have  reached 
and  have  twisted  out  of  shape  the  old  established  or- 
der. It  is  only  natural  that  these  many  changes 
should  find  their  chief  expression  in  international  ex- 
change, for  here  business  relations  appear  in  their 
world  aspect. 

2.  Interiiational  exchange  and  civilization. — That 
foreign  exchange,  the  adjustment  of  all  our  financial 


2  INTERNATIONAL  EXCHANGE 

relations  with  the  world  beyond  our  borders,  lies  at 
the  very  basis  of  civilization  is  no  mere  figure  of 
speech.  Attempts  to  formulate  in  words  just  what 
the  mind  pictures  by  such  comprehensive  ideas  as 
*'civilization"  are  likely  to  be  unsatisfactory.  They 
say  too  little  to  be  satisfying  or  they  say  too  much 
to  be  concise  and  definite.  One  essential  of  civiliza- 
tion which  all  recognize,  however,  is  that  of  orderly 
intercourse  among  men  of  the  same  nation  and,  as 
civilization  advances,  of  different  nations.  Isolation 
whether  of  the  individual  or  the  nation  is  the  contrast 
to  civilization.  Whatever  hampers  and  impedes  such 
intercourse  promotes  isolation,  whatever  facilitates  in- 
tercourse between  men  and  nations  promotes  civiliza- 
tioUc 

The  first  effect  of  the  Great  War  on  the  United 
States  was  to  break  down  the  long  established  ex- 
change relations  between  New  York  and  London  and 
other  financial  centers.  It  seems  not  unlikely  that 
the  reestablishment  of  stable  exchange  among  the  na- 
tions of  the  world  may  be  the  last  step  in  the  economic 
reconstruction  thru  which  the  world  is  passing.  In- 
ternational exchange  touches  the  heart  of  the  eco- 
nomic situation  past,  present  and  future. 

3.  Interest  of  the  unusual. — When  business  moves 
along  in  its  accustomed  gait  we  think  very  little  of  its 
operations,  and  we  take  as  a  matter  of  course  the  deli- 
cate adjustments  of  its  various  parts,  just  as  a  man 
in  good  health  gives  little  thought  to  his  digestive  sys- 
tem.    In  normal  times  the  slight  fluctuations  of  inter- 


EXCHANGE  SITUATION  S 

national  exchange  may  be  of  moment  to  the  ex- 
porter and  the  banker — they  are  his  professional  in- 
terest— but  they  are  of  little  concern  to  the  business 
men  of  the  nation  at  large.  International  payments 
which  involve  no  shipment  of  gold  arouse  little  inter- 
est in  the  business  world.  But  when  gold  is  exported 
or  imported  attention  is  immediately  drawn  to  the 
fact,  and  from  one  end  of  the  country  to  the  other  the 
daily  press  gives  explanations  more  or  less  accurate 
of  what  is  taking  place. 

Ever  since  the  great  conflict  of  the  nations  broke 
out  in  August,  1914,  the  disorder  in  our  exchange  re- 
lations with  foreign  countries  has  been  followed  from 
day  to  day  with  absorbing  interest  by  men  of  business, 
as  well  as  by  the  general  and  financial  press.  The 
machinery  w^hich  determined  the  in-and-outflow  of 
gold  and  thus  regulated  the  rates  at  which  adjust- 
ments between  different  countries  were  made  was 
stopped.  Violent  fluctuations  in  these  rates  appeared 
and  while,  thru  governmental  rather  than  commercial 
means,  these  rates  were  steadied  during  the  war,  the 
period  since  the  Armistice  has  been  one  of  great  vari- 
ation and  uncertainty. 

4.  Fluctuating  standards,  national  and  interna- 
tional.— In  international  relations  such  fluctuations  in 
exchange  rates  cause  disorders  of  the  same  nature  as 
follow  in  domestic  affairs  from  variations  in  the 
money  standard.  It  is  not  necessary  to  depict  in  de- 
tail the  difficulties  which  grow  out  of  a  fluctuating 
paper  standard  of  money.    Changes  in  its  value  in- 


4  INTERNATIONAL  EXCHANGE 

troduce  an  element  of  uncertainty  into  every  business 
relation.  Men  live  from  day  to  day  not  knowing 
what  the  morrow  will  bring  forth.  Business  arrange- 
ments become  a  series  of  temporary  makeshifts. 
Men  are  unable  to  work  and  plan  for  the  future  be- 
cause that  futui^e  is  vague  and  uncertain.  Business 
is  reduced  to  a  minimum,  and  under  these  conditions 
the  foundations  of  progress  cannot  be  laid.  Busi- 
ness does  not  stop, — it  cannot  stop — but  it  lacks  en- 
terprise and  hope. 

It  is  the  same  in  international  relations.  The 
needs  of  nations  remain  as  before.  Interchange  of 
commodities  between  the  different  parts  of  the  world 
cannot  cease.  But  with  rates  of  exchange  fluctuating 
from  day  to  day  intercourse  between  the  nations  is 
hampered  in  the  same  way  as  if  tariff  barriers  were 
shifted  frequently  and  capriciously. 

5.  Normal  exchange  relations, — In  part  the  out- 
growth of  national  needs  for  commodities  which 
could  not  be  produced  at  home,  in  part  the  outgrowth 
of  pohtical  and  financial  relations,  there  had  grown 
up  in  the  years  that  preceded  the  War  well-established 
commercial  and  financial  relations  among  the  nations 
of  the  earth.  They  were  not  fixed  and  immutable, 
but  subject  to  constant  tho  from  year  to  year  rela- 
tively slight  changes  as  conditions  in  the  different 
countries  varied.  The  economic  literature  of  the  day 
consisted  in  no  small  part  of  a  discussion  of  how 
changes  in  one  country  affected  conditions  in  another. 
It  is  a  truism  that  the  business  structure  of  one  coun- 


EXCHANGE  SITUATION  5 

try  is  only  part  and  parcel  of  the  business  structure 
of  the  world  at  large.  International  exchange  there- 
fore reflects  both  internal  and  external  conditions. 

6.  Internal  change  wrought  by  war, — Separating, 
as  far  as  it  is  possible  to  do  so,  internal  from  external 
conditions,  let  us  briefly  summarize  the  events  and 
legacies  of  the  Great  War  which  have  entirely  thrown 
out  of  balance  the  traditional  exchange  relations 
among  the  nations. 

Among  the  belligerents  there  was  a  great  destruc- 
tion of  productive  property,  and  this  destruction  was 
not  evenly  distributed.  Belgium  and  northern 
France  were  laid  waste,  and  the  fruits  of  centuries 
of  the  up-building  process  were  wiped  out.  Other 
belligerents  escaped  this  fate  tho  the  Allied  nations, 
particularly  Great  Britain,  and  some  neutrals  suf- 
fered considerable  losses  in  shipping. 

Among  the  belligerents  again  there  was  a  great  de- 
struction of  man  power  thru  the  sacrifices  of  battle 
and  disease.  Tho  the  phrase  man  power  is  frequently 
given  a  purely  military  meaning  its  significance  for 
the  world's  production  cannot  be  overlooked.  Econo- 
mists may  speculate  whether  in  certain  areas  there 
may  not  be  overpopulation,  but  with  a  given  popula- 
tion, none  of  them  would  look  for  any  benefit  from 
the  destruction  of  its  most  active  and  productive  ele- 
ments. And  again  it  may  be  noted  that  this  destruc- 
tion of  life  was  not  evenly  distributed  among  the  bel- 
ligerent nations. 

In  all  the  nations  participating  in  the  Great  War 


6  INTERNATIONAL  EXCHANGE 

there  was  further  a  great  destruction  of  potential 
wealth,  thru  the  diversion  of  industry  to  the  manu- 
facture of  the  means  of  warfare,  thru  the  attendant 
taxes  and  the  huge  legacy  of  debt  which  has  been  left 
for  future  generations  to  liquidate.  Nor  was  this 
burden  evenly  distributed. 

Nor  could  the  neutral  nations  wholly  escape  the  di- 
rect internal  effects  of  the  war.  This  was  especially 
true  of  the  Netherlands  and  Switzerland  which  were 
obliged  to  make  relatively  large  military  expenditures 
for  the  defence  of  their  neutrality.  The  smaller  neu- 
trals in  Europe  and  the  larger  ones  of  Latin  America 
were  indirectly  drawn  into  the  economic  turmoil  thru 
being  cut  off  from  sources  of  supply  for  their  manu- 
factures and  personal  consumption,  and  thru  the  diffi-, 
culty  in  some  instances  in  finding  an  outlet  for  their 
native  products. 

7.  Monetary  disturbance, — Thus  during  and  after 
the  war  the  nations  have  staggered  under  its  burden. 
Their  whole  economic  life  was  directed  to  the  single 
purpose  of  warfare  and  all  the  checks  and  balances 
which  guided  it  in  times  of  peace  were  set  aside.  No- 
where could  the  monetary  standard  be  maintained  in 
its  full  integrity.  Gold  which  had  generally  been  the 
background  if  not  the  actual  embodiment  of  the  mone- 
tary circulation  became  exclusively  a  factor  of  gov- 
ernment finance  rather  than  the  mainstay  of  com- 
merce. The  convertibility  of  currency  into  gold  was 
suspended,  and  the  only  check  on  the  issue  of  currency 
which  civilization  has  established  as  effective  ceased 


EXCHANGE  SITUATION  7 

to  operate.  Paper  money  under  various  names  mul- 
tiplied in  the  different  countries  at  different  rates., 
and  suffered  varying  degrees  of  depreciation  as  re- 
vealed in  the  rise  of  local  prices. 

With  such  changes  going  on  in  the  currencies  of 
nations  it  was  impossible  for  exchange  rates  not  to  be 
powerfully  affected.  When  depreciation  is  uniform 
among  a  group  of  states  it  is  conceivable  that,  other 
things  being  equal,  exchange  rates  would  not  change. 
But  "other  things"  were  far  from  being  equal  in  the 
world  crisis  and  depreciation  was  far  from  being 
uniform  in  the  nations  concerned.  Hence  the  fiscal  re- 
lations of  these  nations  not  only  with  those  which  were 
able  to  maintain  the  integrity  of  their  currency  but 
also  among  themselves  were  shifted. 

8.  Ejcternal  relations  in  tcartijne. — Let  us  turn 
our  attention  to  certain  external  relations.  Western 
Europe  is  unable  to  produce  all  the  food  required  for 
its  dense  population.  Even  before  the  war  it  drew 
large  quantities  of  food  from  Eastern  Europe  and 
from  other  continents,  exchanging  manufactured 
products  for  it.  It  was  the  manufacturing  center  of 
the  world,  tho  it  had  to  draw  upon  other  lands  for 
many  of  its  raw  materials.  The  extensive  commer- 
cial relations  to  which  these  exchanges  gave  rise  had 
made  London  the  financial  center  of  the  world,  ex- 
tending its  influence  into  all  the  corners  of  the  earth„ 
To  London,  lands  far  and  near  looked  for  financial 
assistance.  The  loans  of  many  governments  were 
floated  there,  and  both  British  and  native  enterprises 


8  INTERNATIONAL  EXCHANGE 

in  all  parts  of  the  world — drew  their  capital  from 
the  same  source. 

Europe  at  war  had  more  imperative  needs  than  be- 
fore. It  needed  more  food,  since  its  own  production 
was  curtailed.  It  needed  arms  and  munitions  and 
supplies  for  the  murderous  conflict  in  which  it  was  en- 
gaged. In  its  extremity  it  turned  to  the  United 
States,  and  the  increased  exports  of  food  and  of  war 
materials  from  this  country  went  far  to  supply  its 
need.  Enormous  payments  had  to  be  made  in  the 
United  States  by  the  allied  governments  and  a  violent 
shifting  of  the  usual  trade  relations  occurred.  Crip- 
pled by  the  war  and  the  demands  which  it  entailed, 
the  London  market  was  no  longer  in  a  position  to 
lend  capital  to  the  rest  of  the  world.  Those  in  South 
America,  Canada,  even  in  Europe  itself  who  were 
wont  to  borrow  money  in  the  markets  of  the  old 
world,  were  forced  to  come  to  New  York. 

9.  Eocchange  before  the  "war. — In  brief  outline 
these  are  the  chief  changes — there  are  innumerable 
smaller  ones — which  have  shifted  and  changed  almost 
beyond  recognition  the  customary  exchange  relations 
among  the  nations.  What  are  the  outstanding  fea- 
tures of  that  situation  then  and  now  as  they  affect 
foreign  exchange? 

The  significant  thing  before  the  War  was  the  exist- 
ence over  large  areas  of  international  standards  of 
value.  Gold  was  the  accepted  medium  of  exchange 
in  foreign  payments  over  the  greater  part  of  the 
civilized  world.     A  smaller  group  of  nations  used 


EXCHANGE  SITUATION  9 

silver  as  its  basis  of  money.  Within  the  group  the 
same  interchangeability  existed  as  in  the  gold  group. 
Moreover  it  is  to  be  noted  that  as  silver  is  a  commodity 
of  world  commerce  a  relationship  to  the  gold  group 
was  always  calculable.  Outside  of  these  two  groups 
there  were  a  few  nations  having  only  a  paper  currency 
with  no  metalHc  background.  It  was  common  to 
speak  of  them  as  being  on  a  paper  standard,  but  it  is 
to  be  noted  that  such  a  standard  is  necessarily  local 
and  is  not  an  international  standard  conmion  to  a 
group  of  countries.  Exchange  with  any  one  of  them 
therefore  will  be  governed  by  considerations  which 
do  not  apply,  or  apply  in  different  measure,  to  another 
country. 

10.  Present  eocchange  situation, — The  distribution 
of  the  nations  of  the  earth  into  gold  standard,  silver 
standard  and  paper  standard  countries  has  been  com- 
pletely changed  by  the  war.  Most  of  the  leading  na- 
tions are  actually  on  a  paper  standard.  They  have 
not  loosened  their  hold  on  gold,  and  in  some  cases 
their  gold  holdings  have  even  increased  since  1914. 
But  paper  money  has  greatly  multiplied  and  gold  is 
no  longer  available  for  local  or  for  international  com- 
merce. Silver  indeed  has  held  its  own  in  international 
payments,  but  gold  has  lost  for  the  time  its  former 
importance. 

How  long  the  present  conditions  will  be  maintained 
no  one  can  foretell.  Certain  it  is  that  the  nations 
which  have  heretofore  used  gold  for  local  and  inter- 
national payments  are  looking  forward  to  a  return  to 


10  INTERNATIONAL  EXCHANGE 

that  basis.  They  hope  to  return  sooner  or  later  to  the 
normal  condition  of  the  free  use  of  gold  in  interna- 
tional exchanges.  Such  normal  conditions  embracing 
both  the  past  and  it  is  hoped  the  future,  have  a  perma- 
nent interest  which  does  not  attach  to  the  present 
more  or  less  temporary  conditions. 

11.  Plan  of  discussion. — Before  the  War  it  was  not 
necessary  to  explain  or  defend  the  traditional  ap- 
proach to  the  detailed  study  of  international  ex- 
changes. Writers  depicted  exchange  conditions  with 
gold  standard  countries,  with  silver  standard  coun- 
tries, and  with  paper  standard  countries  in  this  se- 
quence, not  only  because  it  treated  the  different 
groups  in  the  order  of  their  importance  but  because 
the  discussion  proceeded  naturally  from  the  simple 
to  the  complex. 

If  we  were  to  follow  today  the  importance  of  the 
different  groups  we  should  have  to  deal  first  with  the 
paper  standard,  but  in  so  doing  we  should  plunge  the 
reader  into  the  most  difficult  phase  of  the  entire  sub- 
ject. If  we  are  to  understand  the  principles  of  in- 
ternational exchange  under  conditions  as  they  are, 
we  must  first  comprehend  them  under  conditions  as 
they  ought  to  be.  That  means  that  it  would  not  be 
wise  to  depart  from  the  traditional  presentation  of  the 
subject  which  presumes  the  existence  of  gold  as  the 
international  money.  It  does  not  mean  that  the  un- 
usual conditions  of  the  present  day  can  be  ignored  in 
the  treatment.  Nor  does  it  mean  that  the  emphasis 
on  the  different  aspects  of  the  subject  will  be  the  same 


EXCHANGE  SITUATION  11 

as  heretofore.  Obviously  greater  attention  must  at 
this  time  be  given  to  the  factors  underlying  interna- 
tional payments  between  countries  on  a  paper  basis. 
Should  any  of  our  readers  deem  that  the  assumption? 
underlying  the  discussion  of  international  exchange 
principles  are  somewhat  remote  from  conditions  as 
they  are  now,  it  would  be  well  to  remember  that  the 
conditions  assumed  are  those  which  the  future,  it  is 
hoped,  will  restore  before  the  world  grows  much  older. 

REVIEW 

In  what  sense  are  stable  exchange  and  civilization  linked  to- 
gether ? 

Describe  the  exchange  situation  before  the  Great  War. 

What  internal  and  external  changes  wrought  by  war  have 
affected  the  exchange  situation? 

WTiat  has  been  and  is  now  the  relative  importance  of  countries 
'''ing  respectively,  a  gold,  silver  and  paper  standard  of  value? 


CHAPTER  II 

FUNDAMENTALS  OF  EXCHANGE 

1.  Clearing  process  in  exchange, — The  funda- 
mental principles  of  foreign  exchange  are  simple. 
The  actual  methods  of  making  international  pay- 
ments, however,  and  the  calculations  involved  are 
somewhat  technical.  A  student  beginning  the  sub- 
ject often  rivets  his  eyes  upon  the  maze  of  exchange 
calculations,  technical  methods  and  the  myriads  of 
varying  circumstances  which  work  together  to  fix  the 
actual  rates,  thus  losing  sight  of  the  underlying  prin- 
ciples which  are  few  and  easily  understood. 

Every  one  knows  that  in  foreign  exchange  the 
business  world  applies  the  familiar  principle  of  off- 
setting one  debt  against  another  and  arranging  to 
adjust  the  balance  either  thru  money  or  credit. 
This  principle  will  be  understood  better  if  portrayed 
first  in  a  simple  illustration  stripped  of  all  the 
mechanism  which  civilization  and  commerce  have 
developed. 

2.  Settlement  of  equal  debts, — Let  us  suppose  that 
Durant  in  Montreal  has  sold  to  Rogers  in  New  York 
a  bill  of  goods  for  $1,000.  He  draws  a  draft  for  this 
amount  on  Rogers  who  must  make  payment  in 
Montreal.  If  Rogers  sends  currency  or  gold,  he 
must  pay  insurance  and  transportation  costs,  and  this 

12 


FUNDAMENTALS  OF  EXCHANGE  13 

is  an  added  burden  to  his  business.  Xow  suppose 
that  at  the  same  time  Peters  in  Xew  York  has  sold 
a  $1,000  bill  of  goods  to  Martin  in  Montreal,  making 
it  necessary  for  Martin  to  send  $1,000  to  Xew  York. 
Clearly,  if  all  four  parties  were  aware  of  these  trans- 
actions, ^Martin  the  ^Montreal  buyer  could  pay  $1,000 
to  Durant  the  Montreal  seller,  and  Rogers  the  New 
York  buyer  could  pay  Peters  the  Xew  York  seller. 
This  would  eliminate  the  necessity  for  any  shipment 
of  money. 

3.  SettJement  of  unequal  debts. — Xow  let  us 
assume  that  the  debts  in  the  foregoing  case  were  not 
equal,  that  $1,500  is  due  to  Montreal  and  only  $1,000 
to  Xew  York.  In  iNIontreal,  jNIartin  can  settle  with 
Durant  just  as  before;  but,  in  Xew  York,  after 
Rogers  has  paid  $1,000  to  Peters  he  must  still  remit 
$500  to  Durant  at  Montreal.  To  ship  this  $500  will 
cost  something  but  it  will  be  less  expensive  than  ship- 
ping the  entire  $1,500.  Furthermore,  the  cost  of 
shipping  $1,000  from  ^Montreal  to  Xew  York  has  been 
saved. 

Multiply  the  four  men  of  our  illustration  by  thou- 
sands, and  we  have  a  picture  which  more  clearly  cor- 
responds to  the  actual  situation.  The  multiplication 
increases  the  amount  of  debts  to  be  adjusted;  it  may 
also  diminish  the  proportion  of  the  entire  debt  to  be 
settled  by  currency  shipments. 

4.  The  dealer  in  ejrehange. — It  may  be  objected 
that  the  above  illustration  is  unreasonable,  that  we 
could  not  possibly  expect  the  four  men,  much  less 


14  INTERNATIONAL  EXCHANGE 

thousands,  to  discover  one  another's  doings.  The 
objection  would  be  well  taken.  But  suppose  that  no 
business  man  in  either  Montreal  or  New  York  under- 
takes to  ship  currency  on  his  own  account  and  that 
there  is  only  one  banker  or  exchange  dealer  in  each 
place  who  is  equipped  to  handle  such  transactions. 
Say,  further,  that  the  Bank  of  Montreal  sends  all 
remittances  direct  to  the  Bank  of  New  York  which 
distributes  the  payments  to  those  entitled  to  receive 
them  in  New  York  and  that,  in  like  manner,  the  Bank 
of  New  York  consigns  all  remittances  to  the  Bank  of 
of  Montreal  for  distribution  there.  All  business  men 
in  New  York  who  owe  money  in  Montreal  will  now 
pay  their  funds  into  the  Bank  of  New  York,  and  all 
those  to  whom  money  is  due  from  Montreal  will  call 
upon  the  Bank  of  New  York  for  it.  The  bank  will 
know  that  it  has  certain  remittances  to  make  but  that, 
on  the  other  hand,  it  has  certain  remittances  due  from 
the  Bank  of  Montreal.  It  will  ship  only  the  balance 
due  Montreal  or  receive  only  the  balance  due  New 
York. 

5.  The  eoochange  rate. — The  banker  or  exchange 
dealer  evidently  renders  a  valuable  service,  for  which 
it  is  only  just  that  he  should  be  paid.  So  long  as  pay- 
ments to  Montreal  equal  payments  to  New  York 
nothing  but  bookkeeping  is  involved,  and  the  bank 
may  assume  the  cost  of  this  as  an  accommodation  to 
its  customers.  Under  these  conditions  exchange  is 
said  to  be  at  par. 

The  moment  a  currency  shipment,  to  Montreal  for 


FUNDAIVIENTALS  OF  EXCHANGE  15 

example,  becomes  necessary,  it  is  only  natural  that  the 
Bank  of  Xew  York  should  make  a  charge.  It  cannot 
charge  more  than  the  expense  incident  to  procuring 
the  money  and  shipping  it ;  if  it  should  do  so  business 
men  would  ship  for  themselves. 

The  bank  may  anticipate  the  necessity  of  shipping 
currency  before  it  actually  arises.  If  business  men 
in  Xew  York  seem  to  be  buying  from  Montreal  more 
than  they  are  selling,  the  Bank  of  Xew  York  may 
begin  to  make  a  small  charge  for  its  services  in  re- 
mitting to  ^Montreal,  increasing  the  charge  as  the 
probability  of  shipment  becomes  more  certain.  The 
cost  is  thus  distributed  over  a  larger  number  of 
buyers,  who  will  pay  the  charge  rather  than  ship 
money  themselves  as  long  as  it  does  not  exceed  the 
cost  to  them  if  they  should  procure  the  money  and 
ship  it.  Under  these  conditions  exchange  on  Mont- 
real is  said  to  be  at  a  premium  in  Xew  York. 

6.  Exchange  at  a  discount. — ^AVhen  Montreal  ex- 
change is  at  a  premium  in  Xew  York,  what  is  hap- 
pening to  Xew  York  exchange  in  Montreal?  There 
the  sellers  overbalance  the  buyers.  Sellers  draw  their 
drafts  upon  Xew  York  and  present  them  to  the  Bank 
of  IMontreal  for  cash.  Some  drafts  are  coming  in 
from  Xew  York  drawn  upon  Montreal  business  men 
who  have  bought  goods,  and  cash  is  received  for 
them;  but  not  enough  to  meet  the  sellers'  demand. 
Under  these  circumstances  the  Bank  of  Montreal 
may  refuse  to  pay  full  face  value  for  drafts  on  Xew 
York,  and  Xew  York  exchange  is  at  a  discount. 


16  INTERNATIONAL  EXCHANGE 

If  the  Montreal  sellers  have  specified  in  their  con- 
tracts with  New  York  buyers  that  payment  must  be 
made  in  Montreal,  they  are  fortunate.  They  need 
not  sell  their  drafts  to  the  Bank  of  Montreal  at  a 
discount  but  may  simply  demand  that  their  debtors 
forward  the  mone3\  If  the  contract  permits  pay- 
ment to  be  made  in  New  York,  however,  they  can- 
not do  better  than  sell  their  drafts  at  a  discount.  Of 
course,  the  discount  cannot  exceed  the  expenses  of 
shipping  the  money  from  New  York  to  Montreal, 
since  they  can  accept  payment  in  New  York  and  make 
the  shipment  on  their  own  account. 

This  illustration  shows  how  important  it  may  be 
for  a  sales  contract  to  specify  whether  payment  is  to 
be  made  in  money  of  the  seller's  city  or  in  that  of  the 
buyer's. 

7.  The  exchange  market, — The  assumption  that 
there  is  only  one  exchange  dealer  in  Montreal  or  New 
York  is,  of  course,  incorrect.  There  are  many  dealers 
or  banks  in  each  city  where  drafts  can  be  bought  and 
sold.  The  Bank  of  New  York  is  in  competition  with 
other  banks  and  dealers,  and,  imder  the  circumstances 
described  above,  cannot  charge  a  premium  on  JNIont- 
real  exchange  greater  than  its  competitors  charge  if 
it  would  hold  its  customers.  In  like  manner,  the 
Bank  of  Montreal  cannot  discount  New  York  drafts 
at  a  rate  higher  than  that  of  its  competitors  if  it  wants 
to  buy  any. 

So  far  it  has  been  assumed  also  that  New  York  and 
Montreal  trade  only  with  each  other ;  but  each  trades 


FUNDAMENTALS  OF  EXCHANGE  17 

with  every  other  important  city  in  the  world.  In 
Montreal,  an  excess  of  sales  to  New  York  over  pur- 
chases from  her  m:iy  be  counter-balanced  by  an  ex- 
cess of  purchases  from  London  over  sales  to  that 
point.  At  the  same  time,  New  York  may  be  selling 
more  to  London  than  she  is  buying.  If  so.  New  York 
can  pay  Montreal  by  drafts  on  London,  thus  avoid- 
ing shipment  of  money.  Montreal  is  content,  be- 
cause she  can  forward  the  drafts  to  London  instead 
of  money. 

8.  Exchange  centers. — It  would  seem  that  the 
practice  just  described  would  lead  to  boundless  con- 
fusion. New  York  might  send  to  Montreal  drafts  on 
Madrid  when  Montreal  had  a  balance  due  from  Mad- 
rid. Montreal  might  then  send  these  to  some  other 
point  where  she  did  owe  an  amount  and  there  again 
they  might  not  be  needed.  How  could  any  point 
determine  what  drafts  to  forward  to  another? 

This  difficulty  was  settled  in  the  natural  develop- 
ment of  international  trade.  London  and  New  York 
are  two  points  with  which  almost  every  city  in  the 
world  is  trading.  Remittances  are  always  being 
made  to  these  points  and  received  from  them.  Con- 
sequently drafts  on  either  may  be  remitted  any- 
where in  settlement  of  debts,  and  they  will  be  ac- 
ceptable because  points  everywhere  need  such  drafts 
to  make  payments  in  one  or  the  other  city.  Drafts 
on  other  cities  are  sometimes  used,  but  usually  they 
are  remitted  to  the  cities  on  which  they  are  drawn  or 
to  nearby  cities.    Drafts  on  any  point  are  acceptable 

xviii — 3 


18  INTERNATIONAL  EXCHANGE 

in  New  York  or  London  because  they  have  remit- 
tances to  make  everywhere.  These  two  cities  are  the 
exchange  centers  of  the  world. 

9.  Gold  points. — In  a  preceding  paragraph  we 
pointed  out  that  the  premium  on  Montreal  exchange 
in  New  York  could  never  go  above  the  expenses 
incident  to  procuring  the  gold  and  shipping  it.  Ship- 
ping expenses  consist  primarily  of  the  cost  of  pack- 
ing, express,  insurance  and  loss  by  abrasion.  In  a 
country  which  is  not  redeeming  its  credit  money  at 
face  value  in  gold,  it  may  be  necessary  to  pay  an 
additional  amount  to  secure  gold  for  shipment. 

The  principle  which  limits  the  premium  on  Mont- 
real exchange  in  New  York  also  limits  the  discount, 
except  that  here  it  is  the  expenses  involved  in  pro- 
curing gold  in  Montreal  and  in  shipping  it  to  New 
York,  that  fixes  the  amount  of  variation. 

Evidently,  at  a  given  time,  there  is  a  point  above 
par  beyond  which  the  price  of  exchange  cannot  rise, 
and  likewise  a  point  below  par  under  which  the  price 
cannot  drop.  These  are  the  points  at  which  it  be- 
comes profitable  to  export  or  import  gold,  and  are 
often  called  the  gold  shipping  points  or  gold  points. 
It  must  be  understood  that  they  vary  with  the  costs  of 
procuring  gold  and  shipping  it. 

10.  Demand  and  supply, — The  price  of  exchange 
fluctuates  between  the  gold  points  according  to  the 
shifting  of  demand  and  supply.  Every  sale  of  goods 
by  an  American  to  an  Enghshman  creates  a  supply 
of  drafts  on  London;  every  purchase  made  by  an 


FUNDAMENTALS  OF  EXCHANGE  19 

American  from  an  Englishman  creates  a  demand  for 
London  exchange.  American  sales  to  England  thus 
tend  to  lower  the  price  of  London  exchange  and  pur- 
chases from  England  tend  to  raise  it. 

Lowering  the  price  of  London  exchange  in  New 
York  means  raising  the  price  of  New  York  exchange 
in  London  and  conversely.  It  will  be  seen  then  that 
every  export  from  the  United  States  tends  to  lower 
the  price  of  exchange  on  the  buying  country,  which 
means  raising  the  price  of  New  York  exchange  in 
that  country.  Every  import  into  the  United  States 
tends  to  lower  the  price  of  New  York  exchange 
abroad. 

11.  Eoochange  as  a  trade  factor, — Thus  far  we  have 
considered  exchange  as  a  result  of  trade  activity.  For 
a  fuller  view  of  the  subject  we  must  also  recognize 
that  exchange  is  an  important  factor  in  determining 
the  trend  of  trade. 

How  this  takes  place  can  best  be  explained  by  con- 
sidering a  case  that  is  hypothetical, — and,  to  lend 
force  to  the  argument,  absurdly  so.  Let  us  assume 
that  in  New  York,  Montreal  exchange  is  quoted  at 
75.  That  means  that  $75  in  New  York  in  goods  or 
money  would  be  worth  $100  in  Montreal,  and  of 
course  the  converse  would  be  true.  If  on  the  face  of 
it,  Montreal  is  an  excellent  place  in  which  to  sell,  it 
would  be  a  bad  2)lace  in  which  to  buy.  What  the  New 
York  merchant  would  gain  on  his  sales  would  be  lost 
on  his  purchases  or  his  remittance.  But  since  this 
exchange  relation  is  wholly  abnormal  a  return  to  par 


20  INTERNATIONAL  EXCHANGE 

would  be  expected.  If  then  when  the  New  York 
merchant  expects  to  cash  in  on  his  sale  the  rate  should 
have  advanced  to  80  he  would  be  the  gainer  by  the 
rise  in  exchange  and  the  hope  of  such  gain  would  im- 
pel him  to  sell.  On  the  other  hand  if  exchange  is  fall- 
ing the  Montreal  merchant  would  have  no  incentive 
to  buy  in  New  York  but  if  from  a  low  point  it  begins 
to  rise  he  is  likely  to  purchase  and  seek  to  reap  the 
benefit  of  such  a  rise. 

The  assumed  facts  are  fearfully  exaggerated  and 
frankly  absurd.  Yet  they  illustrate  an  important 
principle.  Exchange  variations  as  we  have  seen  fluc- 
tuate within  very  narrow  limits  and  one  might  well  be 
skeptical  whether  these  variations  would  start  any 
such  selling  and  buying  movements  as  have  been  sug- 
gested. 

Now  the  margins  of  profit  on  such  operations  are 
very  slight.  They  would  offer  little  incentive  to 
trade  to  the  grocer  or  the  dry  goods  dealer.  But 
there  are  other  commodities  and  other  markets  which 
are  extremely  sensitive  to  changes  such  as  these.  First 
of  all  there  is  the  money  market,  the  market  for  securi- 
ties of  all  sorts  and  the  organized  markets  for  grain 
and  other  produce.  They  operate  on  very  small  mar- 
gins and  thru  the  magnitude  of  their  operations  small 
profits  become  important  sources  of  revenue. 

Just  how  these  various  financial  transactions  are 
stimulated  by  exchange  operations  and  affect  ex- 
change rates  must  be  reserved  for  subsequent  treat- 


FUNDAMENTALS  OF  EXCHANGE  21 

ment.  It  is  important  at  this  point  to  note  their  ex- 
istence. 

12.  The  role  that  money  plays. — In  the  preceding 
chapter  there  was  considerable  insistence  upon  the 
role  that  money  plays  in  determining  exchange  rela- 
tions. In  the  present  chapter  exchange  has  been  ex- 
plained largely  as  a  means  of  making  payments  with- 
out the  transfer  of  money.  These  two  standpoints 
are  only  in  appearance  contradictory.  The  relation 
that  money  bears  to  the  exchanges  is  exactly  the  same 
as  that  which  it  bears  to  other  forms  of  credit  opera- 
tions. Banking  operations  dispense  with  one  use  of 
money,  as  a  medium  of  exchange,  but  without  money 
they  would  be  inconceivable.  The  money  function 
is  a  composite  one  and  we  are  apt  to  speak  loosely  of 
doing  away  with  the  use  of  money  when  at  best  we 
simply  economize  one  of  its  uses.  Back  of  all  credit 
transactions  whether  in  local  or  foreign  affairs  stands 
money.  It  is  the  language  in  which  they  are  expressed 
and,  more  than  that,  it  is  the  medium  thru  which 
credit  differences  are  adjusted.  The  more  highly  de- 
veloped the  credit  system  the  smaller  will  be  the 
amount  which  requires  such  cash  adjustment,  but  we 
have  not  yet  reached  a  point  where  we  can  entirely 
dispense  with  its  use  for  such  purposes. 

Our  explanations  of  exchange  operations  have 
thruout  had  the  background  of  the  existence  of 
money  equally  acceptable  to  all  parties  to  the  transac- 
tions. When  such  a  condition  obtains  the  phenomena 
of  exchange  present  their  simplest  forms. 


22  INTERNATIONAL  EXCHANGE 

13.  Eocchange  with  foreign  centers, — The  fact  that 
two  communities  which  trade  with  one  another  belong 
to  different  nations  does  not  of  itself  affect  exchange 
relations.  Exchange  operations  may  be  affected  by- 
differences  in  currencies  but  the  underlying  principles 
remain  the  same. 

Since  the  explanations  thus  far  given  assume  the 
existence  of  money  equally  acceptable  to  all  parties 
we  may  distinguish  three  different  situations. 

1.  Where  the  money  of  two  countries  is  identical 
and  has  completely  free  circulation  in  both. 

2.  Where  the  money  of  two  countries  tho  identical 
does  not  circulate  in  both  but  is  readily  convertible 
from  one  to  the  other. 

3.  When  the  money  basis  is  the  same,  but  denomi- 
nations different,  with  ready  convertibility  of  one  to 
the  other  with  or  without  concurrent  circulation. 

If  we  go  back  a  few  years  we  find  that  the  first  con- 
dition prevailed  in  the  relations  of  Paris  with  Brus- 
sels, Geneva  and  other  points  in  the  nations  of  the 
Latin  Union,  the  second  condition  existed  in  the  re- 
lations of  New  York  to  Canadian  centers,  while  the 
third  was  found  in  New  York's  relation  to  London, 
Paris,  Berlin  and  other  centers  of  countries  having 
the  gold  or  the  gold  exchange  currency  standard. 

It  is  to  be  noted  that  the  condition  of  such  ex- 
changes is  either  concurrent  circulation  of  money  or 
its  free  convertibility  or  both  combined.  A  word  of 
explanation  is  perhaps  needed  with  regard  to  the  com- 
bination here  noted  which  applies  chiefly  to  gold. 


FUNDAMENTALS  OF  EXCHANGE  23 

The  chief  use  of  gold  in  the  monetary  circulation  of 
most  nations  has  been  as  a  reserve  for  the  banks.  In- 
asmuch as  the  chief  foreign  banks  are  by  law  per- 
mitted to  hold  a  part  of  their  gold  reserve  in  coins  of 
foreign  nations  it  is  in  a  sense  proper  to  say  that  the 
American  double  eagles  stored  in  the  vaults  of  the 
Bank  of  England  had  circulation  in  Great  Britain. 
At  that  time  the  converse  was  not  true.  American 
banks  could  hold  no  part  of  their  reserve  in  foreign 
coin  and  on  receiving  it  had  to  transform  it  into  Amer- 
ican gold  either  in  bars  or  coin. 

In  international  exchange  gold  circulates  by  weight 
rather  than  by  denominations,  but  there  are  certain 
forms  such  as  the  coins  of  the  leading  nations  and  bars 
of  the  leading  mints  which  have  the  preference.  It 
may  be  noted  that  an  examination  of  the  customs  re- 
turns for  gold  imported  into  the  United  States  ordi- 
narily reveals  that  the  greater  part  of  it  comes  to  the 
country  in  the  form  of  American  coin  or  American 
treasury  bars  and  only  a  small  part  in  foreign  coin. 

14.  Countries  using  the  same  money. — If,  as  was 
formerly  the  case  in  the  countries  forming  the  Latin 
Monetary  Union,  the  coins  of  one  country  circulate 
freely  by  law  in  another,  exchange  among  them  offers 
no  problem.  All  exchange  is  expressed  in  familiar 
terms  which  allows  even  those  not  very  well  in- 
formed to  perceive  the  premium  or  the  discount. 
Quite  similar  is  the  situation  in  countries  which  use 
different  coins  which,  however,  have  the  same  gold 
value,    sometimes    the    same    name.     A\Tien    before 


24  INTERNATIONAL  EXCHANGE 

the  Great  War  New  York  traded  with  Montreal  and 
settled  its  transactions  by  exchange  operations,  it 
was  hardly  aware  of  the  fact  that  it  was  engaging  in 
foreign  exchange.  The  two  places  used  the  same 
dollar  as  to  weight  and  fineness  and  exchange  on 
Montreal  and  exchange  on  New  York  was  in  each 
case  practically  quoted  in  domestic  currency.  Ex- 
change bridges  the  gap  between  two  countries  very 
simply,  so  long  as  there  is  the  possibility  of  the  free 
movement  of  money  of  the  same  kind.  As  we  shall 
see  later  even  the  designation  or  value  of  the  money 
unit  is  quite  immaterial  if  the  kind  is  the  same. 

Of  recent  years  Canadian  exchange  has  been  at  a 
marked  discount.  Such  a  discount  would  be  im- 
possible if  the  money  in  circulation  were  in  effect  of 
the  same  kind.  This  is  not  the  case.  As  an  after- 
math of  the  Great  War,  Canada  has  been  obliged  to 
depart  for  the  time  being  from  the  gold  basis.  So 
long  as  the  paper  money  of  the  Dominion  cannot  be 
converted  into  gold,  the  gold  standard  which  exists  by 
law  is  in  fact  suspended.  Under  these  circumstances 
the  Canadian  dollar  is  quite  a  different  thing  from  the 
American  dollar,  tho  under  normal  conditions  they 
are  practically  identical. 

Exchange  rates  between  countries  having  the  same 
monetary  units  as  was  the  case  between  the  United 
States  and  Canada  a  few  years  ago  are  readily  under- 
stood because  they  are  expressed  in  the  same  mone- 
tary language.     Deviations  from  exact  equality  are 


FUNDAMENTALS  OF  EXCHANGE  25 

measured  in  terms  with  which  the  business  world  is 
thoroly  f  amihar. 

15.  Countries  using  diiferent  coinages, — A  few 
years  ago  when  London  reckoned  all  its  transactions 
in  gold  pounds  sterling,  and  New  York  figured  its 
dealings  in  gold  dollars,  exchange  relations  in  ap- 
pearance were  somewhat  more  complicated  than  those 
which  have  been  thus  far  discussed.  This  complexity 
lies  however  chiefly  in  the  appearance.  Both  coun- 
tries were  using  the  same  money  metal,  gold,  and  in 
both  it  was  freely  available  for  the  needs  of  trade. 
The  only  difference  lay  in  the  coins  used.  But  since 
in  international  affairs  gold  circulates  by  weight  it  is 
only  necessary  to  compare  the  pure  gold  in  the  sov- 
ereign with  that  in  the  dollar  to  establish  the  relation 
in  which,  with  exchange  at  par,  one  coin  could  be  ex- 
changed for  the  other.  This  ratio  called  the  Mint 
par  of  exchange  was  £l  =  $4.8665.  When  exchange 
on  London  cost  more  than  $4.86  2-3  it  was  at  a  pre- 
mium, when  less  it  was  at  a  discount. 

16.  Countries  with  different  money  standards. — 
Thus  far  we  have  discussed  exchange  relations  be- 
tween countries  having  a  like  monetary  standard. 
The  existence  of  what  then  becomes  international 
money  is  helpful  and  convenient  for  the  development 
of  commerce,  but  it  is  not  essential  to  it.  Trade  be- 
tween countries  on  a  different  money  standard  con- 
tinues and  as  we  have  seen  in  the  preceding  chapter 
is  possibly  the  dominant  form  of  international  trade 
for  the  time  being.     It  introduces,  however,  into  the 


26  INTERNATIONAL  EXCHANGE 

fixing  of  exchange  rates  a  variety  of  new  considera- 
tions. For  the  orderly  development  of  the  subject 
it  seems  advisable  to  defer  the  consideration  of  these 
exchanges  until  there  has  been  a  full  consideration  of 
all  the  phenomena  of  exchange  based  on  interna- 
tional money — gold.  These  phases  of  the  subject 
wiU  therefore  receive  first  attention. 

REVIEW 

Explain  the  exchange  as  a  clearing  process. 

How  do  you  account  for  premiums  and  discounts  in  exchange? 

What  is  the  role  of  banker  ?  What  is  meant  by  exchange  mar- 
ket and  exchange  center? 

Within  what  limits  will  exchange  usually  fluctuate?  How  are 
those  limits  fixed? 

Explain  how  money  is  at  the  basis  of  exchange  rates  and  the 
effect  if  any  of  different  moneys  of  the  same  kind  in  the  problems 
involved. 


CHAPTER  III 

INTERNATIONAL  PAYMENTS— ORIGIN 

1.  How  indebtedness  between  two  countries  arises, 

— The  mutual  indebtedness  of  two  countries  arises 
from  a  combination  of  the  following: 

Exports  of  merchandise 

Investments  abroad 

The  purchase  of  foreign  securities 

Payments  of  interest  and  dividends  to  foreign 
shareholders 

Charges  for  transportation,  insurance  and  com- 
missions paid  to  foreign  corporations 

Tourists'  expenditures,  etc. 

There  are,  of  course,  many  other  causes  which  affect 
the  course  of  the  exchanges,  but  the  above  are  the 
principal  factors  in  the  fluctuations,  formally,  the 
balance  of  payment,  as  it  is  called,  is  sometimes  with 
one  country,  sometimes  with  another,  and  the  rate  of 
exchange  accordingly  rises  and  falls  within  certain 
well-defined  limits.  Between  countries  on  the  gold 
standard  these  limits  are  determined  by  the  cost  of 
shipping  gold  from  one  country  to  the  other.  The 
rate  of  exchange  may  be  defined  as  the  price  of  the 
money  of  one  country  reckoned  in  the  money  of  any 

27 


28  INTERNATIONAL  EXCHANGE 

other  countn%  that  is,  the  price  of  the  right  to  gold 
of  a  certain  established  weight  and  fineness.  As 
many  countries  have  not  yet  removed  their  embargoes 
against  gold  shipments  by  other  agencies  than  the 
governments,  this  price  must  temporarily  be  consid- 
ered not  as  the  price  of  their  standard  gold  coin  but  of 
currency  with  the  lessened  quantity  of  gold  behind  it 
resulting  from  the  increase  of  its  amount  in  propor- 
tion to  gold  reserves. 

The  principal  operations  of  foreign  exchange  in- 
clude the  issue  of  drafts  and  various  forms  of  com- 
mercial paper,  money  orders,  letters  of  credit  payable 
abroad,  cable  transactions  and  the  purchase  and  ship- 
ment of  bullion  and  of  foreign  coin. 

2.  Interdependence  of  exports  and  iviports. — If 
merchandise  were  the  only  basis  of  international  in- 
debtedness the  value  of  the  exports  would  have  to  be 
equal  to  that  of  the  imports  or  else  trade  would  prac- 
tically cease.  Suppose  a  country  which  does  not  it- 
self produce  gold,  has  an  excess  of  imports,  for  which 
it  could  pay  only  by  shipping  gold.  To  a  limited  ex- 
tent this  could  be  done,  but  its  supply  of  gold  would 
soon  be  exhausted  and  the  only  way  to  replenish  it 
would  be  to  reduce  the  amount  of  imports  below  that 
of  its  exports.  Furthermore,  the  loss  of  gold  from  a 
country  induces  a  fall  in  the  prices  of  goods  (a  rise 
in  the  value  of  money)  and,  owing  to  the  depletion  of 
the  bank  reserves,  a  rise  in  interest  rates  follows.  It 
would,  therefore,  become  a  good  country  to  buy  from, 
and  a  poor  country  to  sell  to.    Automatically,  exports 


IXTERNATIOXAL  PAYMENTS  29 

would  be  stimulated  and  imports  checked  until  the 
balance  was  reversed. 

In  practice,  however,  the  exports  of  a  country  are 
not  confined  to  merchandise  but  include  other  ele- 
ments known  as  "invisible  exports,"  which  offset  im- 
ports of  merchandise.  ''Visible  exports"  consist  of 
merchandise  of  every  description,  including  gold; 
they  are  so  called  because  accurate  records  of  all 
goods  and  specie  entering  or  leaving  a  country  are 
kept  by  the  customs  and  port  authorities.  Every 
vessel  clearing  from  a  port  must  declare  its  cargo  be- 
fore leaving,  and  all  goods  entering  the  country  are 
examined  and  valued  at  the  custom  house.  This 
system  affords  a  fairly  accurate  record  of  the  visible 
exports  and  imports  of  a  country.  A  country's  "in- 
visible" foreign  trade  is  so  called  because  no  such 
record  is  available  owing  to  its  nature.  It  consists 
of  the  import  and  export  of  services,  of  bonds,  shares 
and  other  evidences  of  indebtedness  and,  not  being 
the  subject  of  government  supervision,  there  is  no 
certain  method  of  ascertaining  the  amount  and  vol- 
ume of  these  transactions.  For  that  reason  they  can 
only  be  roughly  estimated. 

The  disparity  between  the  visible  exports  and  the 
visible  imports  of  the  principal  countries  of  the  world 
for  the  year  ending  December  31,  1913,  which  repre- 
sents normal  trade  conditions,  will  demonstrate  the 
importance  played  by  the  invisible  exports  and  the 
invisible  imports  in  adjusting  the  balances  of  pay- 
ments among  the  countries  of  the  world. 


30  INTERNATIONAL  EXCHANGE 

Imports  Exports 

(Last  six  ciphers  omitted) 

Great  Britain $3,080  $2,371 

Germany 2,545  2,132 

United  States 1,717  2,311 

France 1,589  1,296 

Austria 726  591 

Canada 670  356 

Russia 603  782 

Denmark 215  156 

Sweden 185  177 

Netherlands 144  188 

Norway 141  87 

It  will  be  noted  that  the  imports  of  the  above  coun- 
tries with  the  exception  of  those  in  the  United  States, 
Kussia  and  the  Xetherlands,  exceeded  the  "visible" 
exports;  the  difference  was  adjusted  by  "invisible" 
exports.  Such  excess  of  visible  imports  does  not 
necessarily  place  a  country  at  a  disadvantage,  for 
in  the  case  of  the  older  countries  goods  are  imported 
to  pay  for  services  (such  as  freight  and  insurance) 
or  to  meet  the  interest  on  foreign  investments.  In 
the  case  of  a  young  country  like  Canada,  however,  the 
excess  of  imports  usually  consists  of  goods  purchased 
with  money  borrowed  abroad  for  capital  expenditure, 
such  as  material  for  railways,  factories  and  public 
w^orks. 

3.  Origin  and  supply  of  foreign  exchange. — Altho 
the  export  and  imjjort  of  merchandise  are  the  basic 
factors  of  international  indebtedness,  the  other  ele- 
ments which  must  be  taken  into  consideration  have  a 
precisely  similar  eifect  on  the  balances  of  indebted- 


INTERNATIONAL  PAYMENTS  31 

ness,  and  they  can  therefore  be  expressed  in  terms  of 
exports  and  imports.  Summarizing  what  has  ah-eady 
been  said,  trade  between  two  countries  on  the  gold 
standard  consists  of  mutual  exchanges  of: 

1.  Merchandise 

2.  Gold 

3.  Services 

4.  Evidences  of  indebtedness. 

For  the  sake  of  simplicity  we  generally  consider  that 
one  country,  say,  the  United  States,  trades  with  an- 
other country,  England,  just  as  if  a  statement  of  ac- 
count were  made  out  daily  and  the  relative  balance 
arrived  at  and  settled.  Such,  of  course,  is  not  the 
case;  the  transactions  occur  among  a  multitude  of 
independent  merchants  and  bankers,  whose  bills  of 
exchange  on  one  another  furnish  the  supply  of,  and 
govern  the  demand  for,  foreign  exchange,  and  thus 
affect  the  price  of  exchange  between  the  two  coun- 
tries in  question.  Bankers  and  exchange  brokers  in 
New  York  and  London  encourage  the  public  to 
utilize  their  services  for  paying  debts  abroad,  and  in 
order  that  they  may  do  this,  also  encourage  those  who 
have  claims  against  persons  abroad  to  sell  these  claims 
to  the  banks  in  the  form  of  bills  of  exchange,  thus 
enabling  the  banks  to  offset  sales  against  purchases. 
In  other  words,  the  banks  are  both  buyers  and  sellers 
of  foreign  exchange.  A  continuous  process  of  assem- 
bling and  distributing  exchange  is  thus  effected  thru 
the  agency  of  banks,  which  act  as  clearing  houses,  and 
eventually  make  a  settlement  between  the  financial 


32  INTERNATIONAL  EXCHANGE 

centers  of  the  two  countries.  Should  New  York 
banks,  for  instance,  be  called  upon  for  more  exchange 
on  London  than  they  are  able  to  buy,  they  must  pro- 
vide funds  to  meet  their  withdrawals  by  exporting 
gold  or  by  some  other  means.  As  a  rule,  gold  ship- 
ments are  avoided  as  much  as  possible  and  the  re- 
quired balance  in  London  is  often  created  by : 

1.  Buying  exchange  on  other  centers  and  sending  to 
London  for  credit. 

2 .  Shipjping  securities  to  London  to  be  sold  or  borrowed 
against. 

3.  Using  finance  bills. 

While  these  expedients  will  receive  detailed  atten- 
tion later  a  word  or  two  of  explanation  may  be  in 
order  at  this  point.  In  the  trade  between  the  United 
States  and  Canada,  there  is  ordinarily  a  balance  to  be 
paid  by  the  latter  country.  Before  the  war  Canada 
was  in  the  habit  of  discharging  this  obligation  by 
drafts  upon  her  largest  customer,  Great  Britain. 

When  a  similar  recourse  is  not  available  resort  is 
often  had  to  stocks  and  bonds.  There  are  a  large 
number  of  such  securities  which  are  international  in 
character,  with  as  ready  a  sale  in  London  as  in  ISTew 
York.  A  transfer  of  such  securities  to  the  London 
market  has  the  same  effect  as  a  shipment  of  gold.  It 
can  therefore  be  used  to  avoid  such  a  shipment.  More- 
over the  market  for  such  securities  is  very  sensitive. 
Slight  variations  in  the  exchange  rate  may  make  Lon- 
don or  New  York  the  better  market  for  the  sale  of 


INTERNATIONAL  PAYJVIENTS  33 

securities  and  will  set  in  motion  almost  instantly  a 
flow  of  securities  from  one  market  to  the  other. 

Finance  bills  which  are  frequently  used  in  the  cir- 
cumstances noted  are  more  in  the  nature  of  a  post- 
ponement than  a  settlement.  They  may  be  briefly 
described  as  a  temporary  expedient  of  sixty  to  ninety 
days  currency,  used  principally  between  seasons  to 
anticipate  a  favorable  change  in  the  exchange  rates. 
Exports,  it  may  be  noted,  especially  cotton  and  wheat, 
are  not  uniformly  distributed  over  the  entire  year.  It 
will  be  readily  understood  therefore  that  exchange 
will  normally  be  low  at  some  seasons  and  high  at 
others. 

These  are  the  principal  methods  resorted  to  in  an 
endeavor  to  adjust  an  excess  of  imports  over  exports; 
if  in  spite  of  them  the  balance  of  payments  remains 
adverse,  gold  is  shipped. 

4.  ''The  United  States  in  account  with  the  world/' 
— The  exports  of  one  country  form  the  imports  of 
another,  and  a  study  of  the  foreign  trade  of  different 
countries  will  show  that  the  component  items  of  the 
exports  and  imports  vary  only  in  degree.  Dean 
Joseph  French  Johnson  in  "]Money  and  Currency" 
gives  a  statement  of  "The  United  States  in  Account 
with  the  World"  (reproduced  on  page  35)  the  head- 
ings of  which  are  comprehensive  and  self-explanatory 
and  call  for  very  little  comment.  The  amounts  of 
the  various  items  under  invisible  exports  and  imports 
are,  of  course,  only  estimates. 

The  exports  of  merchandise  exceed  the  imports  for 


34  INTERNATIONAL  EXCHANGE 

the  typical  year  under  consideration,  as  they  did  in 
1913,  and  the  difference  was  adjusted  by  the  "invisi- 
ble imports."  The  statement  shows  that  gold  was 
both  exported  and  imported,  indicating  that  in  the 
course  of  the  year  it  was  found  necessary  at  times  to 
import  gold  to  correct  a  falling  rate  and  at  other  times 
to  export  gold  to  adjust  a  rising  rate. 

The  invisible  exports  and  imports  can  be  considered 
under  broader  classifications  as  net  balances  offsetting 
the  excess  of  visible  exports,  as  shown  in  the  following 
statement ; 


INTERNATIONAL  PAYMENTS 


35 


» 


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36  INTERNATIONAL  EXCHANGE 

Excess  of  visible  eayports: 

Merchandise $440,000,000 

Gold 36,000,000 

Total  excess  of  exports $476,000,000 

Excess  of  invisible  exports: 

Interest  and  Profits  (5  and  6) $  55,000,000 

Tourists  and  Embassies  (9  and  10)    150,000,000 

Ocean  Freight  (11)    100,000,000 

Investments  (3  and  4)    106,000,000 

Special  Transactions    (12)    50,000,000 

Balance  due  by  Foreign  Banks  (T  and  8)   .  15,000,000 

$476,000,000 

The  above  statement  shows  that  the  United  States 
paid  $305,000,000  in  goods  for  interest  and  services, 
took  over  $156,000,000  in  investments,  and  still  had  a 
credit  balance  of  $15,000,000  in  foreign  banks. 

5.  Significance  of  the  elements  in  the  balance, — In 
the  list  which  has  been  given  there  are  certain  ele- 
ments whose  importance  is  universally  recognized  and 
appreciated  and  which  call  for  more  extended  con- 
sideration in  subsequent  chapters.  First  in  impor- 
tance are  the  exports  and  imports  of  merchandise,  the 
backbone  of  all  international  trade  relations.  They 
are  usually  the  dominant  element  in  determining  the 
exchange  rate.  Next  come  a  group  of  relations  which 
might  be  described  as  financial  rather  than  commer- 
cial. These  concern  investments,  permanent  and 
temporary,  and  banking  relations  which  form  the  sub- 
ject matter  of  international  finance  and  as  important 


INTERNATIONAL  PAYMENTS  37 

modifying  conditions  must  receive  special  considera- 
tions in  a  volume  on  international  exchange. 

The  other  elements  listed  tho  they  may  run  into 
millions  of  dollars  are  of  minor  importance.  It  is 
sufficient  here  to  note  their  existence.  Before  the 
Great  War  American  travel  abroad  and  in  a  lesser 
degree  the  residence  of  American  officials  and  citizens 
in  foreign  countries  called  for  a  steady  supply  of  ex- 
change in  the  form  of  letters  of  credit  and  traveler's 
checks.  These  in  effect  covered  American  purchases 
abroad  and  from  the  standpoint  of  international  ex- 
change it  must  be  wholly  immaterial  whether  those 
purchases  and  services  were  consumed  where  bought 
or  whether  they  reached  the  United  States  in  the  form 
of  imports.  The  restriction  of  travel  during  the  war 
period  and  the  months  following  the  armistice  checked 
this  stream.  During  1920,  however,  it  began  to  flow 
again  at  a  rate  which  had  seldom  been  equalled  before 
that  year.  Again,  the  United  States,  with  its  inade- 
quate merchant  marine,  formerly  paid  hea^y  toll  to 
foreign  countries  for  freight,  as  practically  all  of  her 
exports  and  imports  were  carried  in  foreign  bottoms. 
Now,  however,  the  situation  has  changed.  A  mer- 
chant marine  has  been  created  and  if  judiciously  op- 
erated should  relieve  American  trade  of  payments  to 
foreign  ship  owners. 

It  is  the  combination  therefore,  of  a  wide  variety 
of  forces,  some  large  and  some  small,  which  fixes  the 
actual  rates  of  exchange  between  nations.  These 
must  be  the  next  subject  for  our  consideration. 


38  INTERNATIONAL  EXCHANGE 

REVIEW 

How  does  indebtedness  between  countries  arise  ? 

What  are  the  invisible  factors  in  the  balance  of  international 
payments  ?    What  are  the  visible  factors  ? 

How  is  the  balance  of  visible  factors  adjusted? 

Describe  Dean  Johnson's  statement  of  the  United  States  in 
account  with  the  world.  What  seems  to  be  the  relative  impor- 
tance of  the  different  elements  of  the  statement? 


CHAPTER    IV. 

GOLD  EXCHANGE  RATES 

1.  Gold  standard. — Before  1914  the  leading  com- 
mercial nations  of  the  world  had  in  fact  as  well  as  in 
law  a  gold  standard  of  currency.  Under  a  gold 
standard  the  money  unit  is  a  definite  quantity  of  gold 
of  a  standard  fineness  which  is  represented  in  the  coin- 
age of  the  country  by  coins  equalling  the  standard  in 
value  or  multiples  or  subdivisions  of  the  same. 

It  is  not  at  all  necessary  to  the  existence  of  the  gold 
standard  that  such  coins  should  pass  freely  from  hand 
to  hand  in  the  daily  transactions  of  the  people.  In 
fact  the  greater  part  of  the  circulation  of  gold  con- 
sists in  the  fact  that  it  lies  hidden  in  the  vaults  of  the 
banks  and  in  the  coffers  of  the  government  as  a  guar- 
antee for  the  value  of  other  currency,  chiefly  paper. 
The  essence  of  the  gold  standard  then  lies  in  the  fact 
that  for  any  of  the  uses  for  which  metallic  gold  is  re- 
quired it  can  readily  be  obtained  by  presenting  at  the 
proper  place  an  equivalent  amount  of  other  currency. 
In  other  words  it  is  the  ready  convertibility  of  all 
forms  of  currency  into  gold  which  constitutes  the  gold 
standard. 

One  of  the  chief  uses  of  metallic  gold  is  to  settle 
the  balances  of  indebtedness  to  foreign  countries  in 
other  words  to  regulate  exchange  relations. 

39 


40  INTERNATIONAL  EXCHANGE 

2.  Gold  exchange  standard. — There  are  a  number 
of  nations  which  have  not  been  able  to  afford  the  lux- 
ury of  the  gold  standard  in  the  internal  monetary  cir- 
culation of  the  country,  yet  which  use  gold  as  a  basis 
of  exchange.  The  government  fixes  a  definite  rela- 
tion between  the  actual  currency  of  the  country  and 
gold,  and  it  undertakes  either  directly  or  thru  the 
banks  to  maintain  this  relation  with  gold  in  all  deal- 
ings with  foreign  countries.  To  do  this  it  must  pro- 
vide a  stock  of  gold  sufficient  to  meet  necessary  de- 
mands for  foreign  payments,  while  at  the  same  time 
it  takes  such  measures  to  maintain  exchange  rates  as 
render  those  demands  as  small  as  possible. 

Thus  exchange  thruout  the  greater  part  of  the 
world  was  a  few  years  ago  conducted  on  a  gold  basis, 
and  if  we  understand  thoroly  the  factors  entering 
into  such  exchange,  the  present,  it  is  hoped,  abnormal 
conditions  of  the  exchange  market  will  be  the  more 
readily  comprehended. 

3.  Monetary  systems. — For  an  understanding  of 
the  facts  of  foreign  exchange  an  acquaintance  with 
the  leading  monetary  systems  is  indispensable.  Each 
of  these  money  units  represents  in  theory  at  least  a 
definite  weight  of  pure  gold.  When  theory  and  prac- 
tice accorded  the  units  of  the  chief  commercial  nations 
were  as  given  in  the  following  table. 


GOLD  EXCHANGE  RATES 


41 


Country  Name    of 

Unit 

Austria-Hun- 
gary   kronen 

Latin    Union.  .  .franc 
Canada      and 
United  States,  dollar 

Denmark    kroner 

Germany    reichsmark 

Holland    gulden 

Japan    yen 

Mexico    peso 

Russia rubles 

Great  Britain,  .pound 


Gross  Weight  Pure  Gold      DoUar  ^  Sterling 

^     .     ^      ^     .  i;  17      •     1     1.  Equivalent 

Grains        Grains   of  Equivalent     .     „ 

^  in  Pence 


5.22776 
4.97817 
25.8 

6.91415 
6.14588 
10.37054 
12.86024 
12.86023 
13.27584 
123.27447 


4.70498 
4.48036 

23.22 

6.22274 

5.53134 

9.33348 

11.57422 

11.57421 

11.94826 

113.00160 


.20262 
.19295 

1. 
.26799 
.23821 
.40195 
.49505 
.49845 
.51456 

4.86656 
or  4.86  2/3 


.lOd 
9.516 

49.316 

13.212 

11.75 

19.82 

24.576 

24.57 

25.37 


The  divergence  of  fact  from  theory  in  the  present 
disturbed  state  of  the  currency  in  most  of  these  na- 
tions will  engage  our  attention  later.  For  the  pres- 
ent we  are  concerned  with  rates  of  exchange  on  the 
gold  basis  of  a  few  years  ago.  Since  the  weight  of 
foreign  coins  is  in  most  countries  officially  given  in 
grammes  a  table  has  been  prepared  and  presented  as 
a  folder  opposite  page  42  making  a  comparison  of  the 
leading  and  some  other  nations  on  this  basis.  The 
term  Latin  Union  in  this  table  embraces  France, 
Italy,  Belgium,  Switzerland  and  Greece.  This  Union 
ceased  to  exist  in  1920  but  the  name  is  retained  here 
as  the  facts  given  pertain  to  an  earlier  period. 

Those  who  have  interested  themselves  in  the  proj  ect 
of  an  international  coinage  have  pointed  out,  that  with 
minor  deviations  there  are  in  effect  represented  in 
this  table  not  more  than  two  distinct  money  systems 
based  respectively  upon  the  shilling  (approximately 
25  cents)   and  the  franc   (approximately  20  cents.) 


42  INTERNATIONAL  EXCHANGE 

This  groups  the  franc  and  the  Austrian  krone  with 
the  Dutch  gulden  which  is  substantially  the  double 
franc.  It  groups  Germany  and  Scandinavia  to- 
gether with  Russia,  Mexico  and  Japan  having  a  dou- 
ble shilling.  The  dollar  appears  as  the  multiple  alike 
of  the  shilling  and  the  franc,  while  the  pound  sterling 
is  of  course,  the  multiple  of  the  shilling  as  well  as  of 
the  franc.  It  is  not  to  be  wondered  that  among  those 
whose  desire  to  remake  the  world  is  innate,  these  ap- 
proximate relations  should  give  rise  to  the  dream  of  a 
pound  that  was  exactly  five  times  the  dollar,  and  a 
dollar  that  should  be  exactly  twice  the  yen  and  the 
rouble,  two  and  a  half  times  the  gulden,  four  times 
the  mark  and  five  times  the  franc.  Nor  is  there  any 
doubt  that  if  this  could  be  brought  about  international 
financial  relations  would  be  greatly  facilitated.  Such 
approximate  relations  as  now  exist  may  be  convenient 
for  a  rough  and  ready  translation  of  one  currency  to 
another,  but  business  is  not  done  that  way.  It  re- 
quires a  more  accurate  calculation  of  these  relations. 

The  theoretical  relations  of  nations  with  another 
are  regulated  by  the  mint  par.  The  actual  relations 
are  governed  by  the  rates  of  exchange  tempered  by 
the  cost  of  shipping  gold.  These  three  matters  are 
intimately  associated  and  should  receive  careful  at- 
tention. 

4.  Mint  par  of  exchange. — The  mint  par  between 
any  two  countries  is  the  value  of  the  monetary  unit 
of  one  country  expressed  in  terms  of  the  monetary 
unit  of  another  country  using  the  same  metal  as  a 


Portugal 

Uruguay 

Newfoundland 

United  States 

Argentina 

Brazil 

Brazil (/"/"■ 

Russia 

Japan 

Netherlands,  The 


Scandinavian  Uni< 
Germany 


£T 


Sovereign 

Escudo 

Peso 

Dollar 

Dollar 

Jlilreis 
Jlilreis 
Rouble 
Yen 

Florin  or ) 
Guilder  i 
Colon 


Rupee 
Krone 


.51457 
.49846 
.40196 

.46535 
.32444 
.26799 
.23821 
.20363 
.19295 


25.371 
24.583 
19.823 


13.216 

11.748 
9.993 
9.516 


.77801 
.532537 
.448023 


1.62571 
1.55615 
1.52551 
1.50463 
1.45161 
.83207 
.48816 
.774234 
.750 
.6048 


No  gold  coins  minted 

33.22  grains 
45/31  grammes 
No  gold  coins  minted 
1/  15  of  £1 


No  gold  coins  minted 
l/l5  of  £\ 
25/63  grammes 
100/379  grammes 
35/82  grammes 
9/  31  grammes 


STATEMENT  OF  EQUIVALENT  VALUES  OF  THE  MONETARY  UNITS  OF  VARIOUS  COUNTRIES. 

Scandinavian     Germany  Austria-  Latin 

Union  Hungary  Union 


Great  Britain £i_  stg, 

Portugal Euudo 

Uruguay Pew 

North  America Dollar 


India  (Br.)_ 


Germany_ 
Austria-H 
Latin  Uni( 


.  Union 
Mark 


.222.019 
.212,518 
.305,484 


.055,068 
.048,949 
.041,636 


26.934,77 
35.371,21 
24.582,17 


13.216,22 
11.747,736 
9.992,76 
9.515,69 


.964,763 
.546,166  ' 
.514,507 


.401,960 
.364,993 
.334,438 


.338,313 
.202,626 
.193,953 


2.400,153 
1.358,760 
1.280,148 
1.340,079 


.666,709 
.592,630 
.504,097 


Marks 
20.429,46 
4.535,733 
4.341,631 
4.197,932 

4.050,000 


Crowns 
34.017,426 
5.333,321 
5.104,140 
4.935,192 

2!695,'433 
2.539,488 
2.460,000 


25.331,54 
5.599,670 
5.360,039 


5.000,000 
2.830,571 
2.666,806 
2.583,333 

2.083,200 
1.891,616 
1.681,436 


Calculations  based  on  15.432,35  grains  to  the  gramme. 


GOLD  EXCHANGE  RATES  4b 

standard  of  value,  tho  the  degree  of  fineness  of  the 
metal  need  not  be  the  same.  All  coins,  whether  of 
gold  or  silver,  are  made  of  so  much  pure  metal  and  so 
much  alloy ;  the  latter  is  used  to  harden  the  coins,  thus 
reducing  abrasion  to  a  minimum.  The  term  "fine- 
ness" expresses  the  number  of  parts  of  pure  gold  or 
pure  silver  contained  in  a  thousand  parts  of  the  com- 
bination. The  British  sovereign  is  916  2-3  parts  fine, 
or  11  parts  fine  gold  and  one  part  alloy.  The  gold 
coins  of  Turkey  and  Brazil  are  also  916  2-3  fine. 
Those  of  nearly  all  other  countries  are  on  a  basis  of 
900  fine,  or  9/10  fine  gold  and  1/10  alloy. 

The  mint  par  is  arrived  at  by  dividing  the  number 
of  grains  or  grammes  of  fine  gold  in  the  one  coin  into 
the  number  contained  in  the  other.  For  instance, 
compare  the  sovereign,  the  unit  of  Great  Britain,  and 
the  gold  dollar,  the  unit  of  the  United  States: 

Gross  weight  of  sovereign 123.27447  grs. 

Less  Vi2  alloy 10.27287  grs. 

Fine  gold  in  sovereign 113.00160  grs. 

Gross  weight  of  dollar , 25.8  grs. 

Less  Vio  alloy 2.58  grs. 

Fine  gold  in  dollar 23.22  grs. 

therefore, 

1         dollar  =  T^^«  =  £.205484  =  49.316  pence 

1  sovereign  =  ^^^^  =  $4.86656 

Similarly,  the  gold  franc  contains  .2903225  gram- 
mes of  fine  gold,  while  the  dollar  contains  1.50463 
grammes.     Hence, 


44  INTERNATIONAL  EXCHANGE 


1         dollar  =  1^?^  =  5.18262  fcs. 


.2903225 

.2903225 
1.50403" 


1  franc  =  ^^f  =  19.2953  cents 


The  mint  par  between  any  two  countries  can  be  ar- 
rived at  in  the  same  way.  The  mint  par  between  two 
gold  using  countries  is  constant.  It  varies  only  when 
one  of  them  alters  its  coinage  regulations  by  increas- 
ing or  decreasing  the  quantity  of  pure  metal  in  its 
monetary  unit. 

5.  Par  of  exchange. — The  mint  par  is  the  pivotal 
point  of  the  rates  of  exchange  between  two  countries. 
In  other  words,  it  is  also  the  ratio  at  which  the  stand- 
ard coin  of  the  country  will  be  exchanged  for  that  of 
another.  Theoretically,  a  sovereign  is  worth  par  in 
Xew  York  ($4.86656) ,  but  practically  this  ratio  holds 
good  only  for  large  amounts.  If  a  traveler  wants  to 
change  ten  sovereigns  in  Xew  York  he  would  prob- 
ably receive  only  $48.50  or  $48.60  for  them  instead  of 
$48.66  2/3,  the  difference  between  retained  by  the 
bank  as  payment  for  its  services  and  to  cover  the  in- 
terest on  the  amount  until  it  had  collected  sufficient 
sovereigns,  say,  one  thousand,  to  warrant  the  trouble 
of  taking  them  to  the  United  States  mint  where  they 
would  be  exchanged  for  $4,866.56,  less  a  small  melt- 
ing charge.  If  a  few  years  ago  the  ten  sovereigns 
were  in  London  to  the  traveler's  credit  and  this  fact 
was  properly  attested  he  w^ould  probably  have  realized 
on  them  by  selling  to  a  Xew  York  bank  the  "right," 
in  the  form  of  a  check  or  order,  to  draw  these  ten  sov- 


GOLD  EXCHANGE  RATES  45 

ereigns  in  London,  and  the  New  York  bank  would 
have  paid  him  their  equivalent  computed  according  to 
the  current  rate  of  exchange.  With  an  active  demand 
for  sterling  exchange  the  seller  would  have  obtained 
a  good  price  for  his  check  on  London.  If,  on  the 
other  hand,  there  were  little  or  no  demand  for  sterling 
exchange  and  the  supply  of  checks  and  bills  of  ex- 
change was  more  than  ample  to  meet  the  demand  he 
would  have  obtained  a  low  price. 

It  has  already  been  pointed  out  that  the  mint  par 
is  merely  the  standard  by  which  actual  exchange  rates 
are  measured.  They  vary  within  narrow  limits,  fixed 
by  the  "gold  points"  or  the  cost  of  shipping  gold.  Ex- 
change rates  find  concrete  expression  in  the  prices 
which  prevail  in  the  sale  and  purchase  of  bills  of  ex- 
change. 

6.  Rates  of  exchange, — Bills  of  exchange  are  a 
commodity  and  as  such  are  bought  and  sold,  and  like 
other  commodities  are  subject  to  the  law  of  supply 
and  demand.  The  reader  should,  for  the  present,  dis- 
miss from  his  mind  the  thought  that  he  is  dealing  in 
the  money  of  foreign  countries  and  should  regard 
bills  of  exchange  and  other  credit  instruments,  used 
in  transferring  funds,  as  representing  a  definite  kind 
of  commodity — evidences  of  indebtedness. 

The  rate  of  exchange  is  the  price  per  foreign  unit 
at  which  the  right  to  collect  these  debts  is  sold  and  it 
does  not  refer,  except  indirectly,  to  the  value  of  the 
gold  monetary  unit.  A  sovereign  is  always  worth 
par  in  New  York  and  the  gold  eagle  always  worth 


46  INTERNATIONAL  EXCHANGE 

par  in  London.  When  gold  sterling  is  quoted  at, 
say,  $4.85  in  Xew  York  it  does  not  mean  that  the 
sovereign  has  depreciated  1  2-3  cents  below  par;  it 
means  that  the  "right"  to  obtain  a  sovereign  in  Lon- 
don is  worth  only  $4.85  in  New  York.  In  this  case 
the  supply  of  these  "rights"  is  ample  and  the  demand 
small,  hence  the  price  falls. 

7.  What  makes  the  rate. — The  rates  of  exchange 
quoted  between  any  two  countries,  therefore,  are  the 
prices  for  checks  and  bills  of  exchange.  These  are 
the  mediums  by  which  debts  are  transferred  from  one 
party  to  another. 

The  rate  of  exchange  between  two  gold  using  coun- 
tries charged  by  a  bank  or  broker  for  a  foreign  bill 
of  exchange  includes: 

1 .  The  mint  par  or  price  equivalent  of  the  foreign  coin . 

2 .  Plus  or  minus  a  premium  or  discount  on  the  mint  par 
(greater  or  less  conversely  to  the  supply  of  bills  on  the 
market  as  compared  with  the  demand  for  them) . 

3 .  Plus  a  premium  or  commission  which  the  banker  .de- 
mands for  his  trouble  and  for  the  economy  and  superior 
convenience  of  a  draft  as  compared  with  a  remittance  in 
coin  or  bullion. 

4.  Less  an  allowance  for  interest,  according  to  the  dis- 
tance between  the  two  points,  and  the  tenor  of  the  draft. 

5.  Plus  the  cost  of  shipping  gold. 

The  rate  of  exchange  paid  by  a  bank  or  broker  for 
a  foreign  bill  of  exchange  includes: 

1.  The  mint  par. 

2 .  Plus  or  minus  a  premium  or  discount  on  the  mint  par . 

3.  Less  a  commission  covering  the  dealer's  profit  and  an 
allowance  for  his  risk  and  trouble. 


GOLD  EXCHANGE  RATES  47 

4.  Less  a  discount,  according  to  the  tenor  of  the  draft. 

5.  Minus  the  cost  of  shipping  gold.    . 

The  mint  par  never  varies.  It  is  a  constant  factor 
in  any  exchange  rate.  The  most  frequent  variations 
in  the  rates  are  found  in  the  premium  or  discount  on 
the  mint  par,  the  range  of  which  is  governed  by  the 
law  of  supply  and  demand,  and  reflects  the  relative 
position  of  two  countries  as  regards  indebtedness. 
The  allowance  for  interest  or  discount  generally 
tends  to  vary  with  the  foreign  interest  rate,  tho  some- 
times in  large  transactions  the  domestic  interest  rate 
becomes  a  factor  also,  in  connection  with  the  financial 
operations  necessary  to  complete  them.  The  cost  of 
shipping  gold  is  modified  and  at  times  offset  by  the 
mutations  in  the  other  factors. 

8.  Coinage  ratio. — The  rate  of  exchange,  therefore, 
must  not  be  confused  with  the  ratio  at  which  one 
country  will  exchange  its  money  for  the  standard 
coins  of  another  country.  If  a  man  has  one  thousand 
sovereigns  in  Xew  York  he  will  receive  par  for  them, 
or  $4,866.56  ^  irrespective  of  the  rate  of  exchange. 
.  9.  Fluctuation  in  the  rate  of  exchange, — The  in- 

1  The  United  States  Mint  will  always  pav  for  English  sovereigrns  at 
the  rate  of  $18.949182  per  ounce.  1,000  sovereigns  weigh  123,247.47 
grains  (480  grains  to  the  ounce  Troy).  Working  this  out,  we  get 
^,866.56  as  the  value*  of  1,000  sovereigns.  As  a  matter  of  fact  the 
United  States  Mint  would  pay  the  bank  90  per  cent  of  this  amount 
($4,380)  on  delivery  and  the  balance  ten  days  later,  less  a  small  charge 
of  four  cents  per  §100  to  cover  melting  expenses,  thus  the  actual  pro^ 
ceeds  would  be  $4,864.61. 

Similarly  the  British  Mint  took  gold  eagles  at  £3:16 i-di/^  per  ounce, 
paying  for  them  a  fortnight  after  delivery  without  any  charge  The 
Bank  of  England  paid  for  them  on  delivery  but  made  a  small  charge  of 
about  IVs^.  per  ounce  to  cover  the  interest  for  14  days  at  4  per  cent. 


48  INTERNATIONAL  EXCHANGE 

termediate  rates  between  the  gold  points  and  the  mint 
par,  that  is,  the  rates  at  which  business  is  usually  done, 
in  addition  to  being  affected  by  the  supply  and  de- 
mand of  bills  between  two  places,  rise  and  fall  in  sym- 
pathy with  the  influences  at  work  on  the  other  ex- 
changes. London,  for  instance,  while  a  debtor  to 
New  York,  might  be  a  creditor  of  Denmark,  France 
or  another  country  with  which  England  has  close  ex- 
change relations.  If  London  drafts  on  these  places 
were  remitted  to  Xew  York  they  would  improve  (i.e. 
raise)  the  rate  of  sterling  exchange  for  the  time  be- 
ing. If,  however,  the  supply  both  of  New  York  and 
Continental  bills  were  to  fall  short,  the  point  at  which 
London  would  have  to  export  gold  would  be  soon 
reached. 

10.  Rates  tend  to  correspond. — The  rates  of  ex- 
change between  two  or  more  places  either  correspond 
or  tend  to  correspond.  Thus,  when  a  few  years  ago 
sterling  exchange  was  at  a  discount  in  New  York, 
say,  at  $4.85,  New  York  funds  in  London  were  at  a 
premium ;  in  other  words,  you  could  purchase  in  New 
York  the  right  to  obtain  a  sovereign  in  London  for 
$4.85,  whereas  for  a  sovereign  in  London  you  would 
only  be  able  to  obtain  the  right  to  $4.85  in  New  York, 
a  dollar  costing  49.50d.  instead  of  49.316d.,  the  par 
value. 

Let  us  suppose  that  the  rate  in  New  York,  in  re- 
sponse to  a  demand  for  sterling,  suddenly  went  to  par, 
and  a  New  York  banker  having  heard  from  his  Lon- 
don correspondent  that  New  York  funds  were  still  at 


GOLD  EXCHANGE  RATES  49 

$4.85,  cabled  him  to  sell  $100,000  at  that  rate  and  as 
a  result  of  this  transaction  the  New  York  banker  re- 
ceived a  credit  in  London  of  £20,618.55.  At  the 
same  time  he  sold  his  own  draft  at  par  against  this 
amount  in  London.  In  actual  practice  he  would  have 
sold  a  draft  of,  say,  £20,000,  but  for  the  sake  of  show- 
ing his  profit  let  us  presume  that  he  sold  a  draft  for 
£20,618.55.  For  this  he  received  $100,343.64  with 
which  he  paid  the  draft  of  $100,000  drawn  on  him  in 
London,  and  thus  makes  a  profit  of  $343.64  less  cable 
charges  and  a  small  commission  to  the  London 
banker. 

By  such  processes  the  exchanges  automatically  reg- 
ulate themselves  between  two  or  more  places.  It  is 
obvious  that  under  the  influence  of  several  such  trans- 
actions marginal  differences  would  rapidly  disappear. 
The  variations  in  the  rates  of  exchange  in  the  case 
cited  are  purposely  exaggerated  for  the  sake  of  illus- 
tration. In  practice,  a  very  slight  difference  in  the 
rates  will  encourage  these  adjusting  transactions, 
which  are  commonly  known  as  arbitrage  transactions. 

11.  Gold  2)oints. — Foreign  exchange,  thru  the  me- 
dium of  bills  of  exchange  and  other  credit  instru- 
ments, enables  countries  to  regulate  their  mutual  in- 
debtedness without  the  transfer  of  coin  or  bullion. 
A  bill  of  exchange  is  a  commodity  like  wheat  and  cot- 
ton, and,  as  such,  it  is  subject  to  the  law  of  supply 
and  demand.  If  the  purchase  rate  of  exchange 
reaches  the  point  at  which  it  is  cheaper  to  remit  gold 

XVIII — 5 


50  INTERNATIONAL  EXCHANGE 

than  to  pay  the  rate  demanded  for  transfer  by  draft, 
gold  exports  usually  result.  The  rates  of  exchange, 
produced  by  buying  gold  in  one  country  and  ship- 
ping it  to  another,  are  called  the  gold  or  specie  points. 
The  mint  or  theoretical  par  remains  invariable  among 
gold  standard  countries.  If  the  exporting  and  im- 
porting of  gold  could  be  effected  without  expense  or 
loss  of  interest,  the  mint  par  and  gold  points  between 
any  two  countries  would  be  practically  identical,  but 
heavy  expenses  for  freight,  insurance,  cooperage,  cart- 
age, abrasion,  interest  while  in  t  ansit  and  other 
charges  are  involved  in  a  gold  shipment.  These  ex- 
penses deducted  from  the  mint  par  give  the  "import 
gold  point"  and  added  to  the  mint  par  give  the  "ex- 
port gold  point;"  that  is  to  say,  if  it  should  cost  more 
to  buy  gold  sterling  exchange  in  New  York  than  it 
would  cost  to  buy  gold  to  the  same  amount  and  ship 
it  to  London,  the  remitter  naturally  would  take  the 
cheaper  method  and  export  gold.  On  the  other 
hand,  when  bills  of  exchange  are  so  freely  offered  in 
New  York  that  the  rate  becomes  abnormally  low,  a 
seller,  if  he  could  obtain  gold  at  par  in  London  for  his 
pounds  there,  would  find  it  cheaper  to  transfer  his 
London  balance  by  importing  the  gold. 

Under  normal  conditions,  the  cost  of  shipping  sov- 
ereigns between  London  and  New  York  is  about  two 
cents  per  sovereign,  and  the  mint  par  of  the  pound 
sterling  is  $4.86  2-3.  Therefore,  when  a  lower  price 
than  $4,841/2  was  a  few  years  ago  offered  for  a  bill 
of  exchange  it  was  cheaper  to  import  the  gold  from 


GOLD  EXCHANGE  RATES  51 

England,  and  when  a  higher  price  than  $4,881/2  was 
asked,  it  was  cheaper  to  send  gold  to  England. 

12.  Significance  of  gold  movements. — The  export 
of  gold  from  Xew  York  to  London  when  gold  is 
readily  available  in  exchange  for  currency  in  both 
countries  implies: 

1.  That  New  York  owes  London  (exchange  is  fa- 
vorable to  London  and  unfavorable  to  Xew  York) . 

2.  That  bills  of  exchange  on  London  have  been 
eagerly  sought  for  in  New  York  in  order  to  liquidate 
this  indebtedness. 

3.  That  the  premium  demanded  by  sellers  in  the 
form  of  a  higher  exchange  rate  exceeds  two  cents  per 
pound  sterling  and  therefore  it  has  become  cheaper 
to  buy  gold  in  Xew  York  and  export  it  to  London. 

Conversely,  the  import  of  gold  to  Xew  York  from 
London  implies: 

1.  That  London  owes  New  York  (exchange  is  fa- 
vorable to  Xew  York  and  unfavorable  to  London). 

2.  That  bills  of  exchange  on  London  have  been  of- 
fered freely  in  Xew  York  to  absorb  this  balance. 

3.  That  the  discount  demanded  by  buyers  in  the 
form  of  a  lower  exchange  rate  exceeds  two  cents  per 
pound  sterling  and  therefore  it  has  become  cheaper  to 
buy  gold  in  London  and  import  it  to  Xew  York. 

13.  Actual  gold  points, — Before  the  war,  when  all 
the  countries  concerned  were  on  a  gold  basis,  the  ex- 
treme range  of  the  gold  points  between  Xew  York 
and  London,  and  the  continental  centers  was  approxi- 
matelv  as  follows: 


52  INTERNATIONAL  EXCHANGE 

Imports  Par  Exports 

New  York  and  London $  4.84i4  ^.86  2/3  $4,881/0  per  £1. 

New  York  and  Paris 5.23  S.lSi/g  5.16  fcs.  per  $1. 

New  York  and  Berlin 94.50  .OSi/g  9G.25  cents  per  4  marks 

London  and  Paris 25.321/2  25.22  25.121/2  fcs.  per  £1. 

London  and  Berlin 20.53  20.43  20.34  mks.  per  £1. 

London  and  Amsterdam.  .  .   12.15  12.10  12.04  florins  per  £1. 

14.  Computing  the  gold  i^oint. — Gold  points  are 
determined  by  the  actual  costs  of  shipping  gold  from 
one  country  to  another  and  of  making  it  available  for 
monetary  use  in  the  country  to  which  it  is  sent. 

The  charges  for  freight  and  insurance  are  readily 
eomprehended.  They  have  been  in  the  last  two  de- 
cades fairly  uniform  and  with  improvements  in  trans- 
portation have  tended  to  grow  less.  They  may  vary 
with  unusual  circumstances,  as  when  the  war  forced 
all  transportation  and  insurance  charges  upward.  In 
August,  1914,  for  example,  the  United  States  could 
have  shipped  gold  to  Europe,  only  at  great  expense. 
In  order  to  provide  the  necessary  payments  an  ar- 
rangement was  made  by  which  gold  was  shipped  to 
Ottawa,  the  Bank  of  England  accepting  payments  in 
London  on  New  York  account  against  this  deposit. 

Another  element  is  the  charge  for  interest  while 
the  gold  is  in  transit.  This  depends  upon  the  rate  of 
interest  and  the  duration  of  transit.  The  improve- 
ment of  ocean  shipping  has  considerably  diminished 
this  charge.  If  as  is  generally  the  case  the  rate  of 
interest  in  New  York  is  higher  than  in  London  it 
would  cost  more  to  ship  a  given  quantity  of  gold 
from  New  York  to  London  than  in  the  contrary  direc- 
tion.     This   among  other  things   explains  why  the 


GOLD  EXCHANGE  KATES  53 

upper  and  lower  "gold  points"  are  not  as  a  rule  equi- 
distant from  the  mint  par  of  exchange. 

The  more  easily  the  foreign  gold  is  made  available 
for  monetary  use  in  the  country  in  which  it  is  received 
the  smaller  will  be  the  divergence  of  the  gold  point 
from  the  mint  par.  Any  obstructions  placed  upon 
this  transfer  will  increase  the  divergence.  Let  us  sup- 
pose for  example,  that  all  banks  are  under  strict  gov- 
ernment supervision  and  are  allowed  to  hold  only 
domestic  gold  coin  as  reserve.  The  foreign  gold  must 
then  be  transformed  into  domestic  coin  before  it  can 
be  used  for  monetary  purposes.  Coinage  may  be 
gratuitous,  in  which  case  there  is  no  added  expense 
except  the  loss  of  interest  during  the  delay  of  manu- 
facture into  coin.  This  is  added  under  such  circum- 
stances to  the  cost  of  shipping  gold  to  that  comitry. 
If,  as  not  infrequently  happens,  there  is  a  small  charge 
say  one  fourth  of  one  per  cent  to  cover  the  costs  of 
coinage,  this  too  must  be  added  to  the  cost  of  ship- 
ping gold. 

15.  Gold  shipments  from  New  York. — The  follow- 
ing description  of  a  shipment  of  $1,000,000  in  gold 
from  Xew  York  to  London  is  taken  from  Dean  Jo- 
seph French  Johnson's  "]Money  and  Currency"  and 
will  serve  as  an  example  of  how  a  shipment  of  gold 
was  made  under  normal  conditions  and  will  illustrate 
the  many  small  factors  which  enter  into  the  compu- 
tation of  costs. 

During  the  last  quarter  of  the  nineteenth  century  the 
cost  of  shipping  gold  from  New  York  to  London  fell  from 


54  INTERNATIONAL  EXCHANGE 

three  to  two  cents  per  pound  sterling.  The  charges  for 
freight  and  insurance  both  declined,  while  the  increased 
speed  of  transatlantic  liners  reduced  the  loss  on  account 
of  interest. 

The  following  figures,  showing  the  cost  of  shipping 
$1,000,000  in  gold  from  New  York  to  London,  were  fur- 
nished by  the  representative  of  one  of  the  largest  New 
York  banking  houses: 

Invested  in  fine  bars,  23,220,000  gr.  (48,375  oz.) $1,000,000.00 

Assay  office  premium  on  bars,  4  cents  per  $100 400.00 

Freight,  5/32  per  cent 1,562.50 

Insurance,  1/16  per  cent 625.00 

Packing  and   cartage .  .  70.00 

Total    outlay $1,002,657.50 

The  Bank  of  England's  "price"  of  gold  varies  from  77s. 
9j/2d'  to  77s.  lOi/^d.  per  ounce,  English  standard,  916^ 
fine.  The  mint  coins  an  ounce  of  gold,  English  standard, 
into  77s.  lOj^d.;  but  the  Bank  of  England,  with  which  it 
is  the  custom  of  bullion  owners  to  deal,  usually  pays  a 
fraction  less  than  this  sum,  thus  saving  itself  from  loss  of" 
interest  while  the  bullion  is  being  coined.  It  is  assumed 
below  that  the  bank  pays  77s.  lOd.  per  ounce. 

48,375  oz.  fine  —  52,772.7  oz.,  916  2/'3  fine. 

52,772.7  oz.  @  77s.  lOd £205,374 

Deduct  sundry  expenses 4 

Net  receipts  in  London £205,370 

Cost  of  sovereign  (1,092,657.50  -4-  205,370) ^.8822 

Mint  par  in  United  States 4.8665 

Cost  of  shipment  per  sovereign $  .0157 

The  reader  will  notice  that  no  loss  on  account  of  interest 
is  included  in  the  foregoing.  The  New  York  banker  who 
furnished  the  figures  held  that  no  such  item  was  involved, 
for  he  sold  sterling  exchange  as  soon  as  he  made  a  ship- 
ment, and  so  was  never  out  of  money  in  consequence.  If 
we  include  interest  for  ten  days  at  three  per  cent  ($835.54) 
we  raise  the  cost  of  the  shipment  to  $.0197  per  sovereign. 


GOLD  EXCHANGE  RATES  55 

16.  Avoiding  gold  shipments. — The  principal  ob- 
ject of  exchange  transactions  is  to  avoid  the  transfer 
of  money  from  place  to  place  and  the  machinery  of 
exchange  operations  is  largely  directed  to  that  end. 
The  early  days  of  the  war  with  the  increased  risk 
and  expense  of  transferring  gold,  gave  rise  to  various 
expedients  which  may  in  modified  form  be  adapted  to 
peace  conditions.  The  usual  method  was  to  deposit 
gold  in  the  debtor  country  for  account  of  the  creditor 
country. 

A  part  of  the  reserve  gold  of  the  Federal  Reserve 
banks  found  safe  repository  for  many  months  in  the 
vaults  of  the  Bank  of  England.  The  Bank  of  Eng- 
land accepted  gold  in  Ottawa  as  equivalent  to  a  ship- 
ment of  gold  to  London.  The  Argentine  Republic, 
Japan  and  other  countries  had  gold  deposited  for 
their  account  in  New  York  and  London.  Some  more 
definite  agreement  along  such  lines  among  the  finan- 
cial interests  seems  to  be  a  not  unlikely  future  de- 
velopment which  will  avoid  still  further  the  costs  of 
shipping  gold. 

17.  Reading  the  exchange  rates. — Within  the 
limits  fixed  under  normal  conditions  by  the  gold 
points,  exchange  varies.  Unless  a  man  is  directly  con- 
cerned in  the  business  of  foreign  exchange  the  in- 
terpretation of  the  exchange  rates  published  in  the 
papers  usually  escapes  him.  Few  iren  are  familiar 
with  the  mint  par  of  exchange  which  is  the  basis  on 
which  actual  rates  are  judged,  and  these  parities  are 
not  always  given  when  actual  rates  are  quoted. 


56  INTERNATIONAL  EXCHANGE 

There  are  two  ways  in  which  exchange  can  be 
quoted,  fixed  and  movable  exchange.  When  ex- 
change is  fixed  the  foreign  unit  is  expressed  in  terms 
of  the  domestic  unit.  Thus,  for  example,  if  the  price 
of  a  pound  sterling  were  quoted  at  $4.87  it  would 
mean  that  this  sum  must  be  paid  for  each  pound  and 
that  exchange  would  be  above  par.  When  on  the 
other  hand  exchange  is  movable  its  price  represents 
the  amount  of  foreign  money  which  can  be  purchased 
for  a  given  quantity  of  domestic  money.  Thus  be- 
fore the  war  the  exchange  quotations  on  francs  meant 
the  number  of  francs  which  could  be  purchased  for 
$1.00.  The  par  was  5.18  18  francs.  If  exchange 
was  quoted  at  say  5.10  francs,  exchange  was  at  a 
premium;  if  it  rose  to  5.25  exchange  was  at  a  discount. 
In  other  words  in  fixed  exchange  the  rise  or  fall  of 
the  quoted  price  varies  directly  with  the  premium  or 
discount,  but  in  movable  exchange  the  rise  or  fall  of 
the  quoted  price  is  inversely  as  the  premium  or  dis- 
count. 

18.  Exchange  quotations. — The  newspapers  gen- 
erally give  exchange  quotations  in  two  columns.  The 
first  column  (b)  gives  the  price  offered  by  buyers, 
and  the  other  (s)  gives  the  sellers'  price;  one  ex- 
pressing the  demand  and  the  other  the  supply.  The 
first  column  gives  the  lowest  quotations — the  buyers 
naturally  offer  as  low  a  price  as  possible,  while  the 
sellers  try  to  obtain  the  highest  price — but  the  real 
or  trading  quotation  is  generally  somewhere  between 
the  two.     There  are  two  classes  of  quotations;  the 


GOLD  EXCHANGE  RATES  57 

posted  rate,  which  is  used  principally  for  small 
amounts,  and  the  actual  or  wholesale  rate,  used  be- 
tween bankers  and  brokers  for  large  transactions. 
As  a  rule,  however,  the  rate  for  very  large  trans- 
actions is  a  matter  of  individual  negotiations  owing 
to  the  frequent  change  in  conditions  during  the  day. 
Furthermore,  the  rates  are  seldom  announced  in  time 
to  be  of  much  use  except  to  show  the  general  trend  of 
exchange. 

The  American  method  of  quoting  dollars  and  cents 
per  foreign  unit  (fixed  exchange)  is  so  simple  that 
it  renders  exchange  quotations  self-explanatory^. 
Canadian  foreign  exchange  quotations  are  governed 
by  the  New  York  exchange  market  and  differ  only 
to  the  extent  of  the  premium  or  discount  on  New 
York  funds  in  Canada. 

Quotations  given  by  the  press  lack  uniformity. 
The  method  adopted  by  the  Federal  Reserve  Bulle- 
tin of  quoting  per  hundred  units  has  advantages,  as 
it  not  only  permits  fine  shading  if  necessary,  but  can 
be  read  either  as  the  dollar  value  of  one  hundred  units 
or  the  cent  value  of  one  unit. 

At  the  beginning  of  1920  a  successful  campaign 
was  started  in  New  York  by  some  of  the  members  of 
the  Foreign  Exchange  Club  with  the  object  of  plac- 
ing French  and  German  quotations  on  the  same  basis 
as  those  of  other  countries.  This  marks  the  begin- 
ning of  a  movement  on  the  part  of  the  leading  New 
York  banks  and  exchange  brokers  to  simplify  ex- 
change procedure,  which  will  go  far  to  dispel  some  of 


58  IXTERXATIOXAL  EXCHANGE 

the  mystery  which  has  hitherto  been  unnecessarily 
thrown  around  exchange  transactions. 

In  the  whole  range  of  business  mathematics 
nothing  more  confusing  or  awkward  can  be  found 
than  the  former  franc  quotation.  It  was  the  only 
movable  exchange  rate  among  the  quotations.  It 
fluctuated  by  five-eighths  of  a  centime  and  close  quo- 
tations were  based  on  the  subtraction  or  addition  of 
sixty-fourths  of  1  per  cent  on  the  dollar  amount. 
There  was  nothing  scientific  or  practical  about  this 
method,  and  it  merely  enabled  some  unscrupulous 
dealers  to  take  advantage  of  the  uninitiated  public. 
People  who  dealt  only  occasionally  in  French  ex- 
change were  prone  to  overlook  the  rule  "Buy  high, 
sell  low,"  and  unconsciously  compared  competitive 
rates  on  the  basis  of  fixed  exchange.  "Buy  low,  sell 
high,  the  better  the  bill,  the  higher  the  rate." 

A  broker  for  instance  who  offers  to  sell  a  draft  on 
Paris  for  Fes  10,000  at  5.18%  would  in  many  cases 
obtain  the  business  against  a  quotation  of  5.19%. 
The  latter  price  looks  the  higher  to  the  customer,  but 
it  is  of  course  the  better  quotation  by  $2.32  in  this  par- 
ticular transaction.  If  the  same  customer  were  sell- 
ing francs  he  would,  with  the  same  reasoning,  prefer 
to  sell  at  5.193/g. 

19.  Range  of  quotations. — A  study  of  the  normal 
equivalents  of  foreign  units  in  the  following  table 
shows  an  almost  steady  progi^ession  in  value  from 
about  18  cents  to  53  cents,  with  only  one  exception, 
sterling  with  its  larger  unit  worth  $4,866.     Sterling 


GOLD  EXCHANGE  RATES  59 

quotations  range  from  4.75  to  4.90,  advancing  by 
5  100  of  a  cent  per  pound,  or  as  it  is  called  5  points 
per  pound.  The  other  quotations  advance  by  steps 
of  .01  cent,  or  one  cent  per  100  units,  thus  18.01, 
18.02,  18.06  and  so  on.  The  last  column  shows  the 
profit  made  on  $1,000  for  every  advance  of  .01  cent, 
the  profit  on  1,000  foreign  units  being,  of  course,  10 
cents  for  each  advance  of  .01  cent  in  the  quotation.^ 

Par    Value  Ordinai-y                  Profit  per 

Country                      Unit  in   Dollars  Range                        $1,000 

Latin     Union Franc  .193  18  to  20  cents           51.8  cents 

Austria-Hungary      Crown  .203  20  to  22  "                49.2     " 

Germany     Mark  .238  22  to  25  "                42.        ". 

Scandinavian     U Crown  .263  26  to  28  "                37.3     " 

Holland     Florin  .402  39  to  41  "                24.9     " 

^I^^^-'^^ - 1  Silver  ]     .              .         1 


South     America Dollar  [    fluctuating    i       41  to  50     "    f  22. 

Japan Yen  .498  50  to  53     "  19. 

Russia     Rouble  .515  50  to  53     "  10. 

Great     Britain Pound  4.866  4.75  to  4.90  02. 

20.  Fijced  and  movable  exchange. — When  foreign 
exchange  is  quoted  in  the  home  currency  per  foreign 
unit,  it  is  called  fixed  exchange;  for  instance,  ex- 
change on  London  is  quoted  in  Xew  York  in  dollars 
and  cents  per  pound  sterling.  The  latter  is  the  fixed 
basis.  The  value  of  the  pound  fluctuates  in  dollars 
and  cents — the  higher  the  quotation  the  higher  the 
cost  of  the  foreign  unit. 

When  the  rate  is  quoted  in  foreign  currency  per 
home  unit  it  is  called  movable  exchange ;  for  instance, 
exchange  on  Paris  is  quoted  in  London  in  francs 
and  centimes  per  pound.    The  fluctuation  is  expressed 

1  The  best  tables  for  general  use  are  to  be  found  in  "Foreign  Exchange 
Tables"  by  E.  D.  Davis,  Minneapolis,  and  "Foreign  Exchange  Explained 
and  Simplified"  by  Howard  K.  Brooks,  Chicago.  Both  of  these  books 
cover  the  whole  range  of  the  foreign  exchanges.  For  sterling,  Hartfield's 
"^'Sterling  Conversion  Tables"  is  the  most  comprehensive. 


60  INTERNATIONAL  EXCHANGE 

in  the  foreign  currency — the  higher  the  quotation  the 
lower  the  cost  of  the  foreign  unit. 

The  United  States  and  Canada  quote  in  fixed  ex- 
change (dollars  and  cents  per  foreign  unit)  tho  for 
large  transactions  with  France  and  some  other  couu; 
tries  movable  exchange  was  formerly  used  almost 
exclusively.  A  homely  illustration  may  make  the 
difference  between  those  two  methods  of  quoting 
clearer.  Sugar  and  other  commodities,  like  fixed  ex- 
change, are  sold  at  so  many  cents  per  pound,  or  per 
hundred  pounds,  and  the  higher  the  price  quoted  the 
less  sugar  (or  foreign  money)  you  will  receive  for  a 
dollar  and  therefore  the  dearer  the  exchange. 

Sugar,  like  movable  exchange,  is  also  sold  at  so 
many  pounds  for  the  dollar  (as  was  the  case  with 
French  exchange)  and  the  more  sugar  (or  francs) 
quoted  for  a  dollar  the  cheaper  the  exchange. 

Fixed  exchange :  cents  per  foreign  unit.  Rule,  buy 
low,  sell  high,  the  better  the  bill  the  higher  the  rate. 

Movable  exchange:  francs  per  dollar.  Rule,  buy 
high,  sell  low,  the  better  the  bill  the  lower  the  rate. 

Rule  for  fixed  exchange. — Buy  low,  sell  high,  the 
lower  the  rate  the  more  foreign  money  received.  The  bet- 
ter the  bill  the  higher  the  rate. 

How  many  francs  can  be  bought  for  $1,000  when  the 
rate  is  19.3  cents  per  franc.^ 

$1,000 ^19.3  =Fcs  5181.35. 

How  much  will  drafts  for  the  following  named  amounts 
cost? 

Fes  5181.35  at  19.35  cents  =5181.35  X19.3  =$1,000. 

Mks  4,000  at  24  cents  =4,000 X. 24  =$960. 

Rule  for  movable  exchange. — Buy  high,   sell  low,   the 


GOLD  EXCHANGE  RATES  61 

higher  the  rate  the  more  foreign  money  received  per  dollar. 
The  better  the  bill  the  lower  the  rate. 

How  many  francs  can  be  bought  for  8900  when  the  rate 
is  5.16 J^  per  dollar.^ 

5.16875  X900=Fcs  4651.87. 

TMiat  is  the  value  of  a  draft  on  Paris  for  Fes  5 ,000  when 
the  rate  is  Fes  5.16>^  per  dollar.^ 

5,000 --5.16875=967.35. 

21.  Premhim  and  discount. — Those  countries 
which  are  fortunate  enough  to  have  a  monetary  unit 
of  the  same  wxight  and  fineness  in  gold  have  no  con- 
versions to  make,  and  do  not  require  any  exchange 
tables.  Among  these  countries  are  the  United  States 
and  Canada  with  the  dollar  in  common,  Great  Britain 
and  her  colonies  with  the  pound  sterling,  and  the 
European  countries  with  the  franc  or  its  equivalent. 
Fluctuations  in  exchange  rates  in  these  countries  are 
quoted  at  either  so  much  per  cent  discount  or  pre- 
mium, or,  as  in  the  case  of  London  and  Australia,  so 
many  units  per  so  many  units,  as  £98  for  £100.  In 
the  former  case,  where  the  percentage  is  small  under 
normal  conditions,  these  rates  correspond  exactly,  a 
premium  in  one  country  corresponding  to  the  dis- 
count in  the  other  country  or  vice  versa.  As  the  per- 
centage in  premium  increases  how  ever,  it  is  necessary 
to  allow  for  a  difference  which  becomes  very  marked 
as  the  rate  increases.  In  the  case  of  the  United  States 
and  Canada,  for  instance,  the  normal  range  of  the 
exchange  does  not  exceed  1/16  of  1  per  cent,  and  a 
premium  on  Xew  York  funds  in  Canada  of  1/16 
w^ould  mean  that  Canadian  funds  in  Xew^  York  ^vould 


62  INTERNATIONAL  EXCHANGE 

be  at  1/16  discount.  The  corresponding  discount  of 
a  premium  of  ^  of  1  per  cent,  or  twenty-five  cents  a 
hundred,  would  be  .24936  per  cent.  Two  per  cent 
premium  would  correspond  to  a  discount  of  1.96078 
per  cent  and  15  per  cent  premium  to  a  discount  of 
13.04348  per  cent.  In  other  words  100  Canadian 
dollars  in  the  United  States  would  be  worth  86.95652, 
and  not,  as  might  be  supposed,  $85.^ 

In  these  days  of  abnormal  quotations  the  neglect 
to  understand  thoroly  the  above  conditions  may  lead 
to  loss  in  exchange  transactions. 

22.  Exchange  tables. — Exchange  tables,  like  inter- 
est tables,  are  most  convenient  and  useful  tools,  and 
tho  formidable  in  appearance  with  their  serried  col- 
umns of  figures,  they  are  simple  in  operation  and  their 
compilation  is  merely  a  matter  of  multiplication.  A 
book  of  exchange  tables  is  really  nothing  more  than  a 
table  of  reciprocals  and  their  multiples. 

All  exchange  tables  give  the  same  information  tho 
some  give  it  in  greater  detail  than  others — the  number 
of  foreign  units  for  so  many  dollars  and  the  number 
of  dollars  for  so  many  foreign  units,  at  various  rates. 
As  an  example,  we  will  compile  a  brief  franc  table  for 

1  The  above  can  be  put  in  the  form  of  a  problem.  If  you  obtain  100 
United  States  dollars  for  115  Canadian,  how  much  do  100  Canadian 
dollars  cost?    This  resolves  itself  into  the  proportion  sum. 

100x100 

115  :   100  :  :  100:  X —  =86.96 

115 

or  a  discount  of  13.04%. 

A  card  compiled  by  Mr.  Patterson,  giving  the  premium  and  discount 

parities  per  $100,  is  published  by  John  W.  Hartfield,  Inc.,  New  York. 


GOLD  EXCHANGE  RATES  63 

the  rate  19.24.     This  represents  the  value  of  a  franc 
in  cents  and  we  must  now  find  the  value  of  one  dollar 


ViT-r    rlivT^inTI 

1                     =    ^   IQTS;    T?nc          TVo    m^o   vir^Txr 

U>        U.l\iaiUll,                             IQ'24.                                          t^.J-OrityjUV 

-O,                  T    T     \^      U.J.  \^      iAVy  TT 

ready  to  compile 

our  table  as  follow 

Rate  19.24  c^nts 

s: 

Francs  per  Dollars         D 

oUars  per  Francs 

100 

519.73052 

19.24000 

200 

1,039.5010 

38.48000 

300 

1,559.2516 

57.72000 

400 

2,079.0021 

76.96000 

500 

2,598.7526 

96.20000 

600 

3,118.5031 

115.44000 

700 

3,638.2536 

134.68000 

800 

4,158.0042 

153.92000 

900 

4,677.7547 

173.16000 

Suppose  we  wish  to  find  the  value  of  5642  francs 
at  the  rate  19.24  cents  to  the  franc.  The  operation 
becomes  one  of  addition: 

5000  francs  =  $96^2.000 
600  francs  =     115.440 
40  francs  =         7.96 
2  francs  =  .3848 


$1085.7848 

To  obtain  the  value  of  $5642  the  process  would  be 
similar.     Using  the  other  column: 

$5,000  =  25,987.526  francs,  etc.,  etc. 

By  continued  multiplication  of  the  too  lines,  this 
table  can  be  extended  indefinitely,  but  the  above  is 
sufficient  to  find  the  equivalent  of  any  sum  up  to 
1,000,000  francs  or  dollars. 

Our  next  table  would  be  at  the  rate  of  19.25,  and  sc 
on  for  every  quotation  that  is  likely  to  be  required. 


64  INTERNATIONAL  EXCHANGE 

REVIEW 

Explain  what  is  meant  by  the  gold  standard  of  currency. 

What  is  the  mint  par  of  exchange  ? 

Explain  the  meaning  of  fluctuations  of  the  actual  rates  of  ex- 
change from  the  mint  par. 

What  determines  the  rates  ? 

Why  do  rates  of  exchange  tend  to  correspond  ? 

What  are  the  gold  points  }  What  is  their  significance  and  how 
are  they  computed  ? 

How  is  exchange  quoted.''  How  do  rates  in  fixed  exchange 
differ  from  those  in  movable  exchange.'' 

What  are  exchange  tables  ? 


CHAPTER  V 

EXPORTS  AND  IMPORTS 

1.  Payments  for  exports . — As  we  have  seen,  the 
movement  of  merchandise  is  not  the  exclusive  factor 
in  the  commercial  relations  of  nations,  which  give  rise 
to  transactions  in  foreign  exchange  but  it  is  none  the 
less  the  dominant  element  in  the  balance  which  has 
been  studied.  The  transactions  to  which  this  mer- 
chandise movement  gives  rise  are  therefore  worthy 
of  especial  attention.  In  the  adjustment  of  commer- 
cial accounts,  bills  of  exchange  are  drawn  with  docu- 
ments attached.  The  chief  of  these  documents  is  the 
bill  of  lading  to  which  the  others,  consular  certificates, 
insurance  certificate  and  letter  of  hypothecation  ^  are 
subsidiary.  The  nature  of  these  documents  needs  no 
detailed  explanation  here,  as  the  form  and  purpose 
of  most  of  them  have  been  fully  explained  in  the 
Modern  Business  Text  on  '^Foreign  Trade  and  Ship- 
ping." 

1  A  letter  of  hypothecation  is  a  certificate  attached  to  a  documentary 
bill  of  exchange  and  signed  by  the  drawer.  It  describes  the  nature  of 
the  shipment,  etc.,  and  states  in  effect  (1)  that  the  bill  of  lading  is  lodged 
as  collateral  security  for  the  acceptance  and  payment  of  the  draft;  (2) 
that  in  case  of  dishonor  the  holder  is  authorized  to  dispose  of  the  goods 
and  apply  the  proceeds  toward  payment  of  the  draft  and  the  expenses 
incurred;  (3)  that  the  drawer  holds  himself  liable  for  any  deficiency,  and 
agrees  to  pay  same  on  demand.  When  an  exporter  sells  a  number  of 
bills  of  exchange  to  a  bank,  a  general,  or  blanket,  hypothecation  certifi- 
cate is  given  to  apply  to  any  and  all  bills  of  exchange  purchased  from  him, 

xviii — 6  65 


66  INTERNATIONAL  EXCHANGE 

The  method  of  using  the  commercial  bill  of  ex- 
change can  be  most  conveniently  explained  by  means 
of  a  concrete  example.  Suppose  a  cotton  merchant 
in  New  Orleans  had  sold  a  quantity  of  cotton  to  a 
Liverpool  firm  against  draft  with  documents  at- 
tached. The  merchant  would  draw  a  sixty  days  draft 
in  duplicate  for  the  amount  of  the  invoiced  goods,  say 
£10,000,  and  take  it,  with  the  relative  documents  at- 
tached, to  his  banker  in  New  Orleans,  who  would 
credit  him  with  $48,500  at  the  rate  of  the  day  which 
we  will  assume  to  have  been  $4.85.  The  merchant 
would  have  sold  his  cotton,  received  his  money  and 
would  be  ready  for  a  new  transaction. 

The  New  Orleans  bank  sent  the  original  bill  and 
documents  to  its  London  correspondent,  the  dupli- 
cates following  by  a  subsequent  steamer.  What  hap- 
pened in  London  to  the  bill  depends  upon  its  nature 
and  whether  the  documents  were  to  be  surrendered  on 
payment  or  on  acceptance.  If  the  documents  were  to 
be  delivered  on  acceptance,  the  bill  would  become  a 
"clean"  bill  and  could  be  discounted  in  the  London 
discount  market  and  the  proceeds  placed  to  the  credit 
of  the  New  Orleans  bank.  If  the  documents  were 
deliverable  on  payment  only,  acceptance  of  the  bill 
would  be  obtained,  but  the  documents  would  remain 
attached  to  the  bill  until  matm^ty,  unless  the  acceptor 
took  up  the  draft  under  a  rebate  of  interest  for  the 
unexpired  time. 

In  the  case  of  an  "acceptance"  bill,  the  proceeds 
became  available  as  soon  as  the  bill  could  be  accepted 


EXPORTS  AND  IMPORTS  67 

and  discounted.  In  the  case  of  a  "payment"  bill  the 
American  banker  could  not  count  on  having  the 
amount  available  until  the  maturity  of  the  bill,  tho 
prepayment  under  rebate  might  have  placed  the 
funds  to  his  credit  long  before  that  time.  If  the  Xew 
Orleans  bank  had  no  London  correspondent  it  would 
have  sold  the  draft  to  its  Xew  York  correspondent, 
who  would  remit  it  to  London  in  due  course.  All 
obligations  on  such  bills  remain  liable  until  payment. 

2.  The  place  of  the  transaction, — Paradoxical  as  it 
may  seem  it  makes  a  considerable  difference  whether 
an  American  exporter  sells  in  a  foreign  market  or  a 
foreign  importer  buys  in  the  American  market.  In 
both  cases  an  export  of  American  goods  follows,  and 
in  both  cases  there  must  be  a  payment  from  the  for- 
eign country  to  the  United  States.  The  difference 
arises  from  the  fact  that  in  the  first  instance  the 
American  merchant  obtains  a  foreign  price  for  his 
wares,  that  is  one  fixed  in  a  foreign  market  and  ex- 
pressed in  foreign  money,  while  in  the  second  case 
he  obtains  an  American  price  fixed  by  his  own  market 
and  expressed  in  dollars.  The  first  case  puts  the  bur- 
den, if  any,  of  exchange  fluctuations  upon  the  seller, 
the  second  puts  it  on  the  buyer. 

In  the  illustration  given  in  the  preceding  para- 
graph, the  price  was  fixed  in  London  and  this  is  the 
usual  rule  in  the  sale  of  cotton.  Where  the  price  is 
fixed  depends  in  large  measure  on  the  higgling  of  the 
market,  in  other  words  on  whether  the  seller  is  more 


G8  INTERNATIONAL  EXCHANGE 

anxious  to  sell  than  the  buyer  is  to  buy  or  the  con- 
trary. 

When  the  United  States  exported  wheat  before  the 
war  it  had  to  adjust  its  prices  to  the  world's  markets, 
and  wheat  sold  abroad  was  sold  at  a  foreign  price. 
The  United  States  competed  with  other  wheat  pro- 
ducing countries  in  those  world  markets.  But  during 
the  Great  War  we  might  say  that  the  markets  came 
to  the  United  States  and  foreign  demand  competed 
directly  with  domestic  demand.  The  enormous  de- 
mand of  the  Allies  for  food  stuffs  had  to  be  satisfied 
almost  wholly  by  the  United  States  and  the  nations 
of  the  world  bought  in  American  markets  and  paid 
American  prices  for  what  they  bought. 

Altho  every  shipment  of  goods  to  a  foreign  coun- 
try involves  foreign  exchange  the  exporter  need  know 
nothing  of  the  intricacies  of  the  latter  if  payments 
are  made  in  his  own  money.  If  he  gets  the  price 
agreed  upon  he  can  afford  to  leave  to  his  customer  any 
consideration  of  how  the  money  is  brought  together. 
It  will  readily  be  seen  that  transactions  with  foreign 
countries  are  greatly  facilitated  when  exporter  and 
importer  deal  in  the  terms  of  money  with  which  they 
are  familiar  and  in  amounts  that  are  perfectly  definite. 

Ten  years  ago  London's  ascendency  in  the  trade 
and  finance  of  the  world  gave  it  this  transcendent  ad- 
vantage over  all  competitors.  It  enjoyed  this  position 
by  virtue  of  the  fact  that  it  was  the  center  of  the 
world's  commerce,  and  it  had  acquired  that  position 
largely  thru  the  fact  that  for  generations  it  had  main- 


EXPORTS  AND  IMPORTS  69 

tained  the  integrity  of  its  monetary  system.  ^ATiile 
other  currencies  may  have  fluctuated  in  value  the 
world  knew  that  a  given  number  of  pounds  sterling 
always  meant  the  same  weight  of  pure  gold.  The 
war  has  shaken  the  supremacy  of  London  by  bringing 
an  inconvertible  paper  money  in  its  train.  The  im- 
pairment of  the  currency  is  less  and  its  fluctuations 
less  violent  than  in  the  Continental  countries  and  the 
trade  position  of  Great  Britain  compared  with  them 
has  not  changed.  But  in  competition  with  the  United 
States  where  the  gold  standard  has  been  maintained 
Britain  labors  at  present  under  disadvantages. 

America  is  less  disposed  than  formerly  to  clear 
its  foreign  exchange  transactions  thru  London.  It 
demands  more  and  more  that  they  be  settled  in  Xew 
York.  That  means  that  in  the  trade  of  the  world  the 
dollar  is  taking  in  part  the  place  long  occupied  by  the 
pound  sterling,  and  that  international  obligations 
whether  they  are  those  of  foreign  governments  or 
those  of  foreign  traders  are  more  frequently  ex- 
pressed in  dollars  than  was  formerly  the  case.  Let  us 
examine  how  this  dollar  exchange  affects  the  pay- 
ments made  for  American  exports. 

3.  Financing  foreign  exports  hy  means  of  dollar 
credits. — ]Many  goods  are  exported  against  dollar 
credits  opened  with  some  New  York  bank,  and  the 
exporter  has  a  simple  dollar  transaction  on  his  hands. 
Since  1916  dollar  credits  have  issued  in  greater  vol- 
ume than  ever  before  and  will  no  doubt  continue  to 
be  more  largely  used. 


70  IXTERXATIOXAL  EXCHANGE 

In  the  first  instance  the  effort  to  estabhsh  dollar 
exchange  was  due  to  the  desire  to  give  trade  with 
foreign  countries  as  nearly  the  aspects  of  a  domestic 
transaction  as  possible.  The  bankers  of  the  United 
States  have  for  a  number  of  years  been  seeking  to 
establish  connections  in  foreign  countries  notably  in 
South  America  with  a  view  to  familiarizing  foreign 
dealers  with  dollar  exchange.  All  these  efforts  have 
been  immensely  stimulated  by  the  w^ar  which  threw 
foreign  currencies  into  disorder. 

The  primary  motive  in  establishing  dollar  credits 
and  dollar  transactions  has  been  to  avoid  loss  thru 
fluctuating  exchange  with  foreign  countries.  Let  us 
consider  the  case  of  an  American  exporter,  say,  Mr. 
Brown  of  Baltimore  who  has  sold  a  bill  of  goods  to 
a  customer  in  Paris. 

He  advises  the  purchaser  to  arrange  a  credit  in 
New  York  in  dollars  for  the  amount  of  the  invoiced 
goods,  to  be  paid  on  delivery  of  the  bill  of  lading  and 
relative  documents.  The  buyer  goes  to  his  banker, 
specifies  the  amount  and  the  terms  of  the  credit  re- 
quired, and  the  banker  writes  or  cables  to  his  New 
York  correspondent  to  open  a  credit  for  so  many 
dollars  in  favor  of  Brown.  In  this  credit  are  set 
forth  the  terms  in  which  Brown  is  to  be  allowed  to 
draw  the  money,  and  the  various  documents  which  are 
to  accompany  the  drafts.  In  due  course  Brown  is 
notified  that  the  credit  has  been  opened.  Accord- 
ingly, he  draws  a  draft  on  Xew  York  and  deposits  it 
in  his  local  bank.     The  draft  is  paid  within  a  few 


EXPORTS  AND  IMPORTS  71 

days  and,  as  far  as  Brown  is  concerned,  the  transac- 
tion is  closed. 

The  Xew  York  bank  having  paid  the  draft  and 
taken  over  the  documents  forwards  them,  debiting  its 
Paris  correspondent  who  opened  the  credit.  If  the 
customer  of  the  Paris  bank  is  of  high  financial  stand- 
ing the  bank  will  probably  turn  over  the  documents 
to  him  at  once,  even  before  full  payment  is  made. 
Otherwise  the  goods  will  be  stored  by  the  bank  on 
their  arrival  and  released  when  payment  is  received. 
This  is  purely  a  matter  of  arrangement  between  the 
Paris  bank  and  its  customer  and  does  not  concern  the 
American  exporter  or  banks.  In  pre-war  days  the 
Paris  bank  might  have  been  unable  to  arrange  a  dol- 
lar credit  on  Xew  York  and  so  issued  instead,  a  credit 
on  London  in  pounds  sterling  against  either  time  or 
demand  drafts  with  documents  attached.  In  either 
case  the  effect  is  to  make  the  matter  of  granting  credit 
one  between  the  purchaser  and  the  Paris  bank,  rather 
than  between  purchaser  and  seller.  This  relieves  Mr. 
Brown  of  any  anxiety  as  to  the  payment.  But  in  the 
first  case  he  draws  against  a  dollar  credit  in  New 
York  which  is  a  simpler  operation  involving  less  cost 
than  drawing  against  a  pounds  sterling  credit  in 
London. 

4.  Dollar  acceptances, — Until  the  establishment  of 
the  Federal  Reserve  banks,  American  foreign  trade 
had  been  financed  chiefly  thru  the  medium  of  letters 
of  credit  issued  on  London  banks.  Establishing  a 
credit  in  London,  and  thereby  providing  an  Enghsh 


72  INTERNATIONAL  EXCHANGE 

acceptance,  was  no  reflection  on  the  high  standing 
of  the  New  York  banks;  it  was  due  to  provisions  of 
the  National  Bank  Act,  which  prohibited  national 
banks  from  doing  an  acceptance  business.  Further- 
more, the  absence  of  an  open  discount  market  in  New 
York  was  another  serious  obstacle  to  the  free  move- 
ment of  foreign  credit.  This  inability  to  finance  for- 
eign trade,  except  thru  London,  was  formerly  a  seri- 
ous handicap  to  the  United  States  in  its  exchange 
relations  with  other  countries.  Spam,  for  instance, 
could  never  settle  in  dollars  for  imports  from  the 
United  States  because  her  imports  from  that  country 
were  paid  for  by  credits  opened  in  London,  and  these 
in  turn  had  to  be  utilized  to  pay  for  credits  opened  in 
London  in  favor  of  the  United  States. 

Mr.  Lawrence  Merton  Jacobs  in  *'Bank  Accept- 
ances"^ referred  ten  years  ago  to  this  feature  as  fol- 
lows : 

As  a  result  of  the  inability  of  our  banks  to  finance  im- 
ports thru  the  acceptance  of  time  bills,  American  importers 
are,  then,  made  dependent  to  a  large  extent  upon  London, 
and  are  required  to  pay  London  a  considerable  annual 
tribute  in  the  way  of  acceptance  commissions.  This  prac- 
tice not  only  adds  to  the  importance  of  London  and  mili- 
tates against  the  development  of  New  York  as  a  financial 
center,  but  it  at  the  same  time  works  serious  injury  to  our 
export  trade.  Since  time  bills  cannot  be  drawn  on  our 
banks  from  foreign  points  against  shipments  of  goods  to 
the  United  States,  there  are  consequently  in  such  foreign 
countries  very  few  bills  which  can  be  purchased  for  remit- 
tance to  the  United  States  in  payment  for  goods  which 

1  Publications  of  the  National  Monetary  Commission,  Document  569. 


EXPORTS  AND  IMPORTS  73 

have  been  bought  here.  In  other  words,  under  our  present 
banking  system  our  imports  do  not  create  a  supply  of  ex- 
change on  New  York,  for  example,  which  can  be  sold  in 
foreign  countries  to  those  who  have  payments  to  make  in 
New  York.  This  means  that  our  exporters  are  also,  to 
their  great  disadvantage,  made  dependent  upon  London. 
It  means  that  when  they  are  shipping  goods  to  South 
America  and  to  the  Orient  they  cannot,  when  they  are 
subject  to  competition,  advantageously  bill  them  in  United 
States  dollars .  They ,  naturally ,  do  not  care  to  value  their 
goods  in  local  currency — that  is,  in  the  money  of  the  coun- 
try to  which  the  goods  are  going — so  their  only  alternative 
is  to  value  them  in  francs  or  marks  or  sterling,  preferably 
the  latter,  owing  to  the  distribution  and  extent  of  British 
trade,  creating  thruout  the  world,  as  it  does  under  the 
English  banking  system,  a  fairly  constant  supply  of  and 
demand  for  exchange  on  London.  When  we  come  to  bill 
our  goods  in  sterling,  however,  it  is  at  once  seen  that  our 
exporters  are  obliged  to  take  a  risk  of  exchange,  which  is  a 
serious  handicap  when  competing  T\ath  British  exporters. 
Our  exporters  who  are  to  receive  payment  for  their  goods 
in  sterling  must  previously  decide  on  what  rate  of  ex- 
change will  make  the  transaction  profitable.  If,  in  an 
effort  to  safeguard  themselves  against  a  loss  in  exchange, 
they  calculate  on  too  low  a  rate  for  the  ultimate  conver- 
sion of  their  sterling  into  dollars,  their  prices  become  un- 
favorable compared  to  those  made  by  British  exporters 
and  they  lose  the  business.  If  they  do  not  calculate  on  a 
sufficiently  low  rate  they  get  the  business  but  lose  money 
on  the  transaction  thru  a  loss  in  exchange. 

The  disadvantages  of  which  Mr.  Jacobs  speaks 
were  those  which  prevailed  at  a  time  when  gold  freely 
circulated  in  the  currencies  of  Great  Britain,  France 
and  Germany.  When  that  free  circulation  ceased 
dollar  exchange  proposed  by  him  as  a  convenience 
became  an  absolute  necessity. 


74  INTERNATIONAL  EXCHANGE 

Under  the  Federal  Reserve  Act,  however,  national 
banks  are  now  permitted  to  accept  drafts  based  on 
the  importation  or  exportation  of  merchandise  and 
the  Federal  Reserve  banks  stand  prepared  to  dis- 
count satisfactory  paper  created  by  this  class  of  busi- 
ness. Under  present  conditions,  the  Paris  bank,  re- 
ferred to  in  the  preceding  section,  would  have  issued  a 
letter  of  credit  instructing  its  New  York  correspond- 
ent to  accept  Brown's  sixty-  or  ninety-day  bill  against 
delivery  of  the  document,  which  bill  after  acceptance 
could  be  discounted  by  Brown's  bank  or  its  New  York 
correspondent  at  one  of  the  Federal  Reserve  banks. 
In  other  words  the  procedure  would  have  been  exactly 
the  same  as  in  the  London  case,  except  that  the  New 
York  and  not  the  London  discount  market  would 
have  carried  the  bill  until  maturity. 

The  Federal  Reserve  Act  has  provided  machinery 
for  such  discounting  and  the  international  financial 
world  is  making  constantly  increasing  use  of  the  fa- 
cilities offered.  It  is  too  soon  to  express  any  opinion 
as  to  the  degree  of  permanence  New  York  will  attain 
as  an  international  acceptance  market.  Nothing  is 
more  sensitive  to  restrictive  conditions  than  interna- 
tional credit — it  must  ebb  and  flow  freely  or  go  else- 
where. Paternalistic  in  all  things  concerning  banking 
and  finance,  the  government  has  surrounded  this  con- 
cession to  modern  requirements  with  restrictions  and 
definitions  that  may  hamper  that  freedom  of  opera- 
tion which  is  so  essential  to  an  international  money 
market. 


EXPORTS  AND  IMPORTS  75 

5.  Ecvport  letters  of  credit. — In  some  countries 
where  banking  facilities  are  undeveloped,  it  was  often 
difficult  for  the  foreign  customer  to  obtain  a  letter  of 
credit  on  Xew  York  or  London,  or  even  to  make  a 
dollar  remittance.  In  financing  exports  to  such 
countries  a  different  system  was  necessaiy  in  order 
that  the  American  exporter  could  obtain  his  money 
without  awaiting  remittance  from  abroad.  This  sys- 
tem was  based  on  the  fact  that  in  such  countries  bank- 
ing relations  with  London  were  more  intimate  than 
those  with  Xew  York.  Out  of  this  fact  grew  a  sys- 
tem of  "export  letters  of  credit"  which  were  issued 
by  an  American  banker  without  the  intervention  of 
a  foreign  bank.  The  service  which  they  perform  in 
financing  exports  can  best  be  understood  by  a  con- 
crete example.  We  will  suppose  that  Williams  of 
Chicago  had  sold  a  shij^ment  of  machineiy  to  a  fii'm 
in  Hondm^as,  where  in  the  absence  of  direct  exchange 
facilities  with  Xew  York,  it  would  have  been  very 
difficult  for  the  Honduras  merchant  to  purchase  a 
draft  on  Xew  York.  Under  these  circumstances 
Williams,  who  did  not  wish  to  wait  until  the  remit- 
tance was  received,  would  have  gone  to  his  banker  with 
invoices,  bills  of  lading  and  other  documents  and 
would  have  asked  him  for  an  export  letter  of  credit. 
The  shipment  we  will  suppose  was  worth  $10,000  and 
against  this  the  Chicago  bank  would  have  given  Wil- 
liams a  letter  of  credit,  authorizing  him  to  draw  at 
ninety  days  against  its  London  correspondent  for 
£1,800  or  about  90  per  cent  of  the  amount  of  the  in- 


76  INTERNATIONAL  EXCHANGE 

voice.  This  draft  on  London  Williams  would  have 
sold  in  the  exchange  market  in  New  York  or  Chicago, 
(letter  of  credit  being  his  authorization.)  In  return 
he  would  have  received  the  bulk  of  his  money  at  the 
current  rate  of  exchange  for  90  day  business.  The 
documents  would  then  be  forwarded  by  the  Chicago 
bank  to  his  correspondent  in  Honduras  who  collects 
the  whole  amount  $10,000.  This  sum  was  remitted 
in  pounds  sterling  to  London  to  the  credit  of  the  Chi- 
cago banker.  Before  the  90  day  draft  originally 
drawn  would  have  matured  there  would  have  been 
received  in  London  more  than  sufficient  funds  to  re- 
tire it  and  neither  the  Chicago  bank  or  its  London  cor- 
respondent would  have  had  to  disburse  any  money. 
The  transaction  would  have  been  closed  by  the  pay- 
ment to  Williams  by  the  Chicago  banker  of  the  dif- 
ference of  the  amount  of  the  draft  and  the  remittance 
from  Honduras  less  any  charges.  As  an  alternative 
the  Chicago  bank  would  itself  have  drawn  the  draft 
on  its  London  correspondent  for  £l,800  and  have 
turned  over  to  the  customer  the  proceeds  in  dollars. 
This  would  have  secured  a  better  rate  and  the  cus- 
tomer would  have  been  saved  the  trouble  of  exchange 
transactions. 

Any  country,  or  any  point,  which  like  London  be- 
fore the  war  has  direct  relations  with  almost  every 
part  of  the  world,  becomes  the  natural  clearing  house 
between  countries  whose  exchange  transactions  with 
each  other  are  limited. 

Under  present  conditions  it  is  not  likely  that  the 


EXPORTS  AND  IMPORTS  77 

transactions  would  be  carried  on  in  this  way.  The 
American  exporter  would  insist  upon  the  payment  in 
dollars.  With  the  growth  of  banking  relations  be- 
tween South  American  countries  and  the  United 
States  he  could  not  only  insist  that  the  merchant  in 
Honduras  should  establish  credit  in  Xew  York,  but 
the  latter  would  be  in  a  much  better  position  to  do  so 
than  would  have  been  the  case  a  few  years  ago. 

6.  Commercial  letters  of  credit  and  importing. — 
Merchants  who  import  goods  into  a  country  can  settle 
for  them  direct  either  by  remittance  or  by  accepting 
a  draft  drawn  by  the  foreign  merchant  but  such 
methods  are  now  seldom  followed  except  in  the  case 
of  minor  transactions.  The  employment  of  letters  of 
credit  as  a  medium  of  settlement  for  import  goods 
offers  greater  advantages  than  any  other  method  of 
payment  both  to  the  exporter  and  importer. 

Altho  of  late  public  attention  in  the  United  States 
had  been  drawn  rather  to  exports  they  are  to  a  con- 
siderable and  perhaps  growing  measure  offset  by  im- 
ports, and  the  financing  of  such  imports  is  a  matter  of 
great  importance.  Thru  the  use  of  commercial  letters* 
of  credit,  the  importer  of  merchandise  is  able  to  buy 
goods  on  a  cash  basis  in  any  part  of  the  world,  even 
tho  the  actual  pa\niient  is  deferred  60  or  90  days, 
which  gives  him  a  chance  to  dispose  of  the  goods  in 
the  meantime.  They  insure  for  him  a  shipment  ofl 
goods  in  the  stipulated  time,  exactly  as  described  in 
the  credit.  He  is  also  able  to  order  in  advance  goods 
to  be  manufactured  according  to  his  specifications  and 


78  INTERNATIONAL  EXCHANGE 

requiremtnts  without  prepayment  in  advance,  the 
letter  of  credit  being  sufficient  security  for  the  ex- 
porter. Formerly  the  majority  of  letters  of  credit 
were  issued  on  London  but  the  recent  war  and  the 
Federal  Reserve  Act  have  brought  out  dollar  credits 
issued  on  New  York  into  more  general  use,  especially 
for  South  American  business. 

This  is  a  growing  business  and  will  no  doubt  within 
a  very  short  time  become  thoroly  familiar  to  the 
American  public.  For  a  long  time,  however,  such 
transactions  were  handled  thru  London  and  because 
this  represents  a  somewhat  more  familiar  relation  and 
at  the  same  time  shows  the  part  which  a  world  ex- 
change center  bears  in  the  financing  of  exports  and 
imports  to  which  it  is  not  directly  a  party  we  may  fol- 
low the  history  of  a  credit  established  in  London. 

7.  British  acceptances  under  letters  of  credit, — Be- 
fore the  Great  War  shook  to  its  foundation  the  finan- 
cial supremacy  of  London  its  bankers  granted  enor- 
mous credits  thruout  the  world  which  took  two  forms 
— acceptances  granted  under  letters  of  credit  or 
finance  bills.  The  following  illustration  will  show  the 
operation  of  an  acceptance  under  a  letter  of  credit. 
When  a  merchant  in  Holland,  France,  the  United 
States  or  any  other  country  wished  to  buy  goods  in 
other  parts  of  the  globe  he  generally  obtained  the 
credit  from  a  London  banker  directly  or  thru  a  banker 
in  his  own  comitry.  In  the  latter  case,  he  instructed 
the  foreign  merchants  from  whom  he  had  made  his 
purchases  to  di'aw  on  the  London  banker  at  so  many 


EXPORTS  AND  i:\IPORTS  79 

months  sight.  Let  us  take  the  case  of  a  tea  merchant 
in  Xew  York,  jNIr.  Young,  who  had  negotiated  with 
Napier  &  Company,  tea  growers  in  Ceylon,  for  a  con- 
signment of  tea.  Xapier  &  Company  probably  knew 
little  or  nothing  about  the  financial  standing  of 
Young,  and  even  if  they  had  known  it  to  be  excellent 
they  would  not  have  been  willing  or  able  to  wait  for  a 
remittance  from  Xew  York  for  the  shipment.  Xapier 
therefore  asked  him  to  arrange  a  credit  in  London 
for  the  amount  of  the  invoice  say  £1,000.  Young 
went  to  his  bankers,  the  Bank  of  Xew  York  and  re- 
quested that  he  open  up  a  credit  in  London  in  favor 
of  Xapier  6c  Company  against  90  day  bills  with  doc- 
uments attached.  The  Bank  of  Xew  York  then  in- 
structed Barclay's  Bank,  their  London  correspondent 
accordingly,  and  Young  was  furnished  with  a  letter 
which  he  could  send  to  Xapier  6c  Company  stating 
that  the  credit  had  been  opened  in  London  at  the 
terms  set  forth.  On  receipt  of  the  letter  Xapier  & 
Company  filled  the  order  and  placed  the  tea  on  ship 
board  receiving  the  bill  of  lading  therefor.  Xapier  & 
Company  then  drew  a  draft  at  90  days  sight  for 
£1,000  and  attaching  the  bill  of  Jading,  insurance 
policy,  invoice,  etc.,  thereto,  took  it  to  their  banker, 
the  Bank  of  ^Madras,  Colombo,  who  purchased  the 
bill  from  them  at  the  current  rate  of  the  day  on  Lon- 
don. Thus  Xapier  &  Company  obtained  their  money 
immediately.  The  Bank  of  ^Madras  forwarded  the 
draft  and  documents  to  its  correspondent  in  London, 
The  Bank  of  Conmierce,  who  without  delay  presented 


80  INTERNATIONAL  EXCHANGE 

it  to  Barclay's  Bank,  the  latter  accepting  it,  retaining 
the  bill  of  lading  and  other  documents.  Later  they  are 
forwarded  to  the  Bank  of  New  York  which  was  thus 
enabled  to  obtain  possession  of  the  tea  when  it  ar- 
rived and  either  store  it  for  their  customer  Young,  on 
account,  or  deliver  it  to  him  on  a  trust  receipt  until  he 
finally  pays  for  it. 

8.  History  of  the  draft  in  London, — To  return  to 
the  draft  which  had  now  become  an  accepted  bill  with 
first  class  names  on  it  and  had  an  international  cur- 
rency. It  was  salable  in  any  country  of  the  world 
because  every  country  at  that  time  found  it  neces- 
sary to  remit  constantly  to  London  and  every  foreign 
bank  had  a  London  office  or  a  London  correspondent. 
The  bill  could  have  been  held  until  maturity  and  the 
proceeds  could  have  been  placed  to  the  credit  of  the 
Bank  of  Madras,  but  the  usual  course  would  have 
been  for  the  latter  to  instruct  its  London  agent,  the 
Bank  of  Commerce,  to  discount  the  bill  in  the  open 
market  and  place  the  proceeds  to  its  credit.  Or,  the 
bill  may  have  been  remitted  by  the  agent  to  another 
foreign  center  to  settle  some  accounts  there.  In 
either  case,  the  bill  whenever  returned  to  London  at 
its  maturity  was  paid  to  the  holder  on  that  date  by 
Barclay's  Bank  altho  in  the  meantime  it  may  have 
been  sold  several  times  and  passed  thru  one-half  dozen 
hands. 

Barclay's  Bank  depended  upon  the  Bank  of  New 
York  to  provide  funds  to  meet  the  bill  at  maturity 
and  would  not  have  issued  the  credit  unless  it  had  had 


EXPORTS  AND  IMPORTS  81 

confidence  in  the  Bank  of  Xew  York.  The  Bank  of 
Xew  York  in  its  turn  had  confidence  in  its  customer's 
abihty  to  reimburse  it  and  of  course  it  insured  that 
the  latter  would  provide  the  necessary  funds  for  trans- 
mission to  London  in  time  to  discharge  the  obligation. 
9.  Position  of  the  ohligants  on  the  hill. — To  sum 
up  the  results  of  the  transaction: 

1.  Young,  the  actual  debtor,  had  the  use  of  £1,000  for 
three  months  and  yet  he,  himself,  would  probably  have 
some  difficulty  in  naming  his  actual  creditor  at  any  par- 
ticular moment. 

2.  Napier  &  Company  in  Colombo  received  their  money 
as  soon  as  the  tea  was  delivered  on  ship  board,  tho  as 
they  had  drawn  the  bill,  they  remain  obligants  until  pay- 
ment. 

3.  The  Bank  of  Madras  bought  the  bill  from  Napier  & 
Company  and  was  only  out  of  its  money  until  the  bill  had 
reached  London,  was  accepted,  discounted  and  placed  to 
the  bank's  credit.  It,  however,  remained  until  the  pay- 
ment of  the  bill  liable  as  its  indorser. 

4.  The  Bank  of  Commerce  advanced  no  money.  It 
acted  only  as  agent  of  the  Bank  of  Madras  in  obtaining 
acceptance  of  the  bill,  selling  it  in  the  discount  market 
and  crediting  the  proceeds.  Therefore,  its  name  did  not 
appear  on  the  bill.  For  its  services  it  received  a  com- 
mission. 

5.  Barclay's  Bank  was  primarily  liable  on  the  bill  as  its 
acceptor,  but  as  the  Bank  of  New  York  had  to  provide 
the  fund  for  payment  the  bank  advanced  no  money 
on  the  transaction,  it  merely  made  a  small  commission 
for  the  use  of  its  money. 

The  above  were  all  interested,  directly  or  indirectly, 
in  the  bill,  but  not  one  of  them  advanced  a  single  cent. 
The  question  still  remains,  "Who  paid  for  the  tea  dur- 

XVIII— 7 


82  INTERNATIONAL  EXCHANGE 

ing  the  three  months  currency  of  the  bill?"  The  an- 
swer is:  "Those  firms  which  discounted  and  purchased 
the  bill  in  the  open  discount  market  of  London." 

10.  The  part  London  plays, — In  much  the  same 
way,  merchants  in  every  country  of  the  world  had 
been  accustomed  to  arrange  credits  in  London  for 
every  other  country  in  the  world  and  for  every  con- 
ceivable class  of  goods.  At  the  outbreak  of  the  war 
it  was  estimated  by  Mr.  Lloyd  George  that  British 
tanks  and  acceptance  houses  were  liable  for  over 
.£350,000,000  of  these  acceptances,  the  greater  part 
of  which  had  been  discounted  on  the  London  market. 
Altho  British  signatures  were  primarily  liable  for  this 
huge  amount,  it  was  not  really  for  their  own  account, 
for  they  looked  to  those  on  whose  behalf  they  had  ac- 
cepted the  bills,  to  provide  the  funds.  The  unprece- 
dented demand  for  sterling  exchange  at  the  begin- 
ning of  the  war  was  due  to  the  attempt  on  the  part  of 
foreign  obligants  to  provide  funds  for  the  maturing 
liabilities  incurred  by  the  British  banks  for  their  ac- 
count, and  under  their  instructions.  Exchange  rates 
on  London  the  world  over  rose  far  above  the  gold 
point.  If  Great  Britain  had  insisted  on  these  debts, 
it  would  have  been  impossible  to  obtain  the  necessary 
sterling  funds  except  at  a  most  rumous  figure.  Even 
if  the  English  banks  could  have  met  the  acceptances 
as  they  matured  out  of  their  own  funds,  disgrace  if 
not  ruin  would  have  befallen  a  number  of  the  foreign 
banks.  It  was  to  protect  this  vicarious  liability  of  the 
English  banks  that  a  moratorium  was  proclaimed  and 


EXPORTS  AND  IMPORTS  83 

there  is  no  doubt  that  this  wise  step  saved  the  neutral 
countries,  indebted  to  London,  both  financial  loss  and 
worry.  Mr.  Lloyd  George  in  referring  to  this  class 
of  notes  says : 

There  was  that  amount  of  paper  out  with  British  signa- 
tures at  that  time.  Most  of  that  had  been  discounted. 
The  cash  had  been  found  by  British  sources,  and  the  fail- 
ure was  not  due  to  the  fact  that  Great  Britain  had  not 
paid  her  creditors  abroad.  It  was  due  entirely  to  the  fact 
that  those  abroad  did  not  pay  Great  Britain.  I  think  that 
it  is  very  important  from  the  point  of  view  of  British 
credit,  to  have  that  thoroly  understood,  for  when  the 
"moratorium"  came,  and  there  appeared  something  like  a 
failure  of  British  credit,  it  was  not  a  British  failure  at  all. 
It  was  because  we  could  not  get  remittances  from  other 
countries.  We  had  already  paid,  but  it  was  vital  to  the 
credit  and  good  name  of  this  country  that  these  bits  of 
paper,  which  are  circulated  thruout  the  globe,  with  British 
names  upon  them,  with  names  that  have  been  associated 
with  British  trade  and  commerce — it  was  vital  to'the  good 
name  and  credit  of  this  country,  to  its  continuity  of  trade 
and  its  character,  that  they  should  not  be  dishonored. 
What  really  happened  was  that  there  was  a  complete  cessa- 
tion of  credit,  a  breakdown  of  the  exchanges.  It  was  ex- 
actly as  if  a  shell  had  broken  an  arch  in  an  aqueduct,  and 
there  was  a  cessation  of  the  flow  that  had  been  going  on 
before,  and  what  we  had  to  do  was  temporarily  to  repair 
the  arch  so  that  the  flow  should  continue. 

Before  the  war  the  acceptances  under  such  letters 
of  credit  were  not,  of  course,  confined  to  London,  tho 
London  was  a  dominant  feature  in  such  financing. 
They  can  also  be  drawn,  and  this  was  done  to  some 
extent,  on  other  large  financial  centers  such  as  New 
York  and  Paris. 


84  IXTERXATIOXAL  EXCHANGE 

11.  Dollar  exchange. — The  relative  position  of 
'New  York  and  London  has  been  greatly  shifted  by 
conditions  growing  out  of  the  war.  American  mar- 
kets no  longer  resort  to  London  exchange  because  it  is 
easier.  Xot  only  that  but  in  trade  with  places  out- 
side of  Xorth  America  there  has  been  a  great  increase 
in  the  number  of  transactions  financed  thru  such  bills 
of  exchange  in  New  York.  International  conditions 
during  the  war  forced  upon  New  York  the  role  of 
the  world's  financial  center.  As  a  result  a  large  part 
of  the  world's  trade  which  had  heretofore  been  ex- 
pressed in  terms  of  sterling  came  to  be  expressed  in 
terms  of  dollars.  For  the  continuance  of  this  condi- 
tion the  financial  disturbance  of  European  countries 
has  been  responsible  and  with  the  increase  in  facilities 
for  such  transactions  which  is  constantly  taking  place 
and  with  the  increased  familiarity  of  the  merchants 
of  the  world  with  them  it  is  hoped  that  New  York  will 
retain  what  it  has  gained  and  make  further  advances. 
The  Federal  Reserve  Bulletin  for  January,  1918, 
stated  that  the  amount  of  outstanding  acceptances 
representing  the  financing  of  foreign  trade  by  Lon- 
don financial  institutions  was  $500,000,000,  while  the 
amount  of  similar  transactions  in  New  York  was 
$210,000,000. 

The  factors  which  make  for  strength  in  the  financial 
world  both  of  London  and  New  York  will  receive  de- 
tailed consideration  in  a  later  chapter.  At  this  point 
it  may  be  remarked  that  there  seems  to  be  no  reason 
why  New  York  should  not  continue  to  finance  Ameri- 


EXPORTS  AND  IMPORTS  85 

can  trade  and  also  share  with  London  in  general  for- 
eign exchanges  if  the  present  growth  of  the  discount 
market  continues.  In  his  book  on  "Foreign  Ex- 
change" (1920),  Mr.  A.  C.  Whitaker  says: 

The  one  great  factor  upon  which  the  development  of  New 
York  as  a  foreign  trade  financing  center  depends  is  the  main- 
tenance there  of  a  discount  market  capable  of  absorbing 
{that  is  buying)  the  great  volume  of  bills  implied  in  this  de- 
velopment,  at  discount  rates  tvtiich  will  aat]rage  as 

LOW  AS  THOSE  OF  THE  OTHER  CENTER  PREPARED  TO  OFFER 

SUCH  A  SERVICE,  NAMELY  LONDON.  Otherwise  the  advan- 
tage will  remain  with  the  sterling  long  bill,  because  ex- 
porters will  get  more  out  of  these  bills  for  their  shipments 
in  the  long  run. 

12.  Exports  and  imports  are  complementary. — In 
analyzing  the  phenomena  of  international  exchange 
as  well  as  any  other  economic  force  it  is  necessary  to 
isolate  for  the  purpose  of  discussion  the  different  fac- 
tors which  enter  into  it.  It  should  not,  however,  be 
forgotten  that  in  the  world  of  business  they  are  inti- 
mately associated  with  one  another  and  that  one  re- 
acts upon  the  other.  In  the  explanation  of  interna- 
tional  exchange  the  impression  is  frequently  given 
that  exports  and  imports  are  fixed  by  entirely  ex- 
traneous considerations  and  that  the  other  elements 
of  exchange  enter  into  the  problem  mainly  for  the 
purpose  of  compensating  the  disparity  which  may 
exist  between  exports  and  imports. 

While  this  is  true  in  some  measure  it  tends  to  oblit- 
erate the  fact  that  there  are  compensating  elements 
as  between  exports  and  imports  wholly  apart  from 


86  INTERNATIONAL  EXCHANGE 

other  considerations.  The  amounts  of  the  exports  and 
imports  of  a  country  depend  not  only  upon  home  pro- 
duction and  foreign  needs  but  also  are  profoundly  in- 
fluenced by  the  relation  of  prices  in  different  com- 
munities. If,  for  example,  the  trade  current  should 
be  such  that  in  a  given  year  one  country  should  re- 
ceive considerable  quantities  of  gold  in  payment  for 
an  excess  of  exports,  this  could  not  fail  to  have  an 
effect  upon  the  price  levels.  Prices  would  rise  in  the 
country  receiving  the  gold  and  would  fall  in  those 
which  had  lost  it.  As  a  result  the  latter  on  account  of 
the  high  prices  prevailing  in  the  gold  receiving  coun- 
try would  be  much  less  disposed  to  buy  from  it  and 
consequently  the  latter's  exports  would  diminish.  On 
the  other  hand,  the  lowering  of  prices  in  the  countries 
which  had  lost  the  gold  would  make  them  good  places 
in  which  to  buy.  In  consequence,  the  gold  receiving 
country  would  increase  its  imports  from  those  coun- 
tries. Thus  it  will  be  seen  that  thru  the  medium  of 
price  changes  there  is  always  a  tendency  towards  an 
equilibrium  in  the  exports  and  imports  themselves. 
The  fact  that  gold  shipments  tend  to  bring  about  a 
dislocation  of  prices,  which  thru  its  influence  on  ex- 
ports and  imports  drops  away  with  the  need  of  gold 
shipments,  that  it  tends  to  an  equilibrium  in  the  ship- 
ment of  merchandise,  is  set  forth  by  Dean  Johnson  in 
his  "Money  and  Currency"  in  the  following  state- 
ment: 

The  reader  will  notice  that  the  movement  of  gold  is  the 
direct  result  of  the  differences  in  the  price  levels  of  Europe 


EXPORTS  AND  IMPORTS  87 

and  America,  which  represent  differences  in  the  value  of 
gold.  He  must  not  suppose  that  the  disparity  of  prices 
is  so  great  as  to  attract  the  attention  of  the  average  man. 
Indeed,  the  average  man  is  not  in  a  position  to  detect  it,  for 
prices  in  the  United  States  are  quoted  in  dollars  and  cents, 
whereas  in  Europe  they  are  quoted  in  sovereigns,  francs, 
marks,  etc.  Nevertheless  the  prices,  whatever  the  names 
used,  show  exactly  the  purchasing  power  of  gold  in  the 
different  countries.  The  large  importer,  or  the  arbitrager 
dealing  in  stocks  and  bonds,  has  at  his  elbow  tables  of 
figures  showing  precisely  the  relation  between  American 
and  European  prices.  When  there  is  a  slight  advance  in 
the  American  price  of  a  good,  without  any  corresponding 
advance  in  the  European  price,  he  at  once  knows  what 
profit  he  can  make  by  purchasing  abroad  and  selling  at 
home. 

Variations  in  the  rate  of  exchange  are  equivalent  to 
changes  in  international  price  levels.  A  rise  of  sterling 
from  $4.8465  to  $4.8865  means  a  rise  of  almost  1  per  cent 
in  the  cost  to  Americans  of  foreign  goods,  and  it  tends 
to  lessen  our  imports  just  as  would  an  actual  rise  in  the 
prices  of  European  goods.  At  the  same  time  this  rise  of 
exchange  from  gold  point  to  gold  point  is  equivalent  in 
foreign  countries — or  wherever  sterling  exchange  is  dealt 
in — to  a  fall  of  almost  1  per  cent  in  the  prices  of  all  Amer- 
ican goods,  for  the  purchasing  power  of  the  sovereign  in 
the  United  States  rises  from  $4.8465  to  $4.8865.  Hence 
American  exports  are  stimulated.  A  decline  of  exchange 
quotations,  of  course,  produces  opposite  effects,  encour- 
aging imports  into  the  United  States  and  discouraging 
exports.  When  the  money  supply  of  the  United  States  is 
relatively  neither  excessive  nor  deficient,  the  changes 
wrought  in  our  foreign  trade  by  the  rise  and  fall  of  ex- 
change quotations  are  usually  sufficient  to  prevent  any 
movement  of  gold.  But  if  the  money  supply  is  excessive, 
so  that  prices  of  certain  goods  having  an  international 
market  are  above  the  price  level  in  other  countries,  then 
our  imports  of  goods  and  securities,  despite  the  discour- 


88  INTERNATIONAL  EXCHANGE 

agement  of  rising  exchange  rates,  continue  in  excess  of 
our  exports  until  an  exportation  of  gold  becomes  profit- 
able. On  the  other  hand,  if  our  money  supply  is  relatively 
deficient,  our  exports  will  be  stimulated  until  the  large 
accumulation  of  sterling  exchange  forces  the  price  down  to 
the  gold-import  point. 

All  these  forces  work  automatically.  No  man  engaged 
in  the  transactions  imagines  that  he  is  doing  anything 
to  correct  the  monetary  situation  of  the  world  or  to  cause 
an  importation  or  exportation  of  gold.  Altho  each 
person  is  seeking  personal  profit  only,  he  inevitably  con- 
tributes to  the  general  result.  Thus,  as  a  result  of  the 
operations  of  men  in  different  countries,  each  acting  inde- 
pendently in  his  pursuit  of  profit,  the  rates  of  foreign  ex- 
change in  each  country  are  so  adjusted  that  the  value  of 
gold  in  all  tends  to  be  the  same,  gold  always  moving  from 
the  country  where  prices  are  relatively  high  and  toward 
the  countries  where  prices  are  relatively  low. 
•  It  thus  appears  that  a  country's  balance  of  indebtedness 
is  not  determined  by  chance.  If  there  were  no  inter- 
national transactions  in  debts  or  securities,  no  move- 
ments of  capital  from  country  to  country, — in  short,  no 
invisible  trade  between  nations, — then  the  exports  and 
imports  of  merchandise  would  balance  except  when  an 
excess  of  gold  in  one  country  lifted  the  price  level  there 
and  brought  about  an  exportation  of  the  yellow  metal. 
The  invisible  elements  in  the  foreign  trade  of  nations 
complicate  the  subject,  but  introduce  no  new  principles 
and  lead  to  no  new  conclusion.  The  balance  of  trade,  so 
far  as  visible  goods  are  concerned,  may  be  more  or  less 
fortuitous ,  depending  upon  the  crops  and  upon  variations 
in  the  productive  capacity  of  a  nation;  but  the  whole  for- 
eign trade  of  a  nation ,  by  which  is  meant  its  imports  and 
exports  of  goods  and  of  debts,  is  subject  to  an  immutable 
law.  The  exports  of  goods  and  debts  always  exactly 
equal  the  imports  of  goods  and  debts,  except  when  a 
balance  of  indebtedness  is  created  on  one  side  or  the  other 
by  differences  in  the  value  of  gold  in  different  countries. 


EXPORTS  AND  IMPORTS  89 

This  balance  of  indebtedness,  it  should  be  noted,  is  not 
the  real  cause  of  gold  exports  or  imports,  but  is  itself  the 
effect  of  conditions  which  render  imperative  a  readjust- 
ment of  the  gold  holdings  of  nations. 

REVIEW 

Describe  the  commercial  bill  of  exchange  and  its  use. 

What  is  meant  by  dollar  credits  ?     How  are  they  used  ? 

Describe  dollar  acceptances.  Why  were  they  not  used  in 
earlier  days? 

Explain  export  letters  of  credit. 

How  do  letters  of  credit  function  in  financing  imports  ? 

Describe  the  part  played  by  the  London  Exchange  market  in 
financing  imports  before  the  Great  War. 

Why  do  exports  and  imports  tend  to  compensate  and  thus 
check  gold  movements? 


CHAPTER  VI 

INVESTMENT  AND  ARBITRAGE 

1.  International  finance. — Intimately  associated 
with  foreign  trade  in  affecting  the  rates  of  exchange 
between  nations  is  a  group  of  operations  which  can  be 
most  conveniently  designated  as  international  finance. 
The  first  step  in  such  relations  upon  which  subsequent 
developments  are  based  is  the  investment  of  one  coun- 
try in  the  funds  and  securities  of  another.  WTien  this 
has  been  going  on  for  a  number  of  years  there  comes 
into  being  a  body  of  securities  with  an  international 
market.  Speculative  transactions  in  such  securities 
known  as  arbitrage  operations  have  similar  effects  on 
rates  of  exchange  as  do  permanent  investments. 

A  second  phase  of  international  finance  which  is 
important  in  this  connection  is  the  growth  of  banking 
interests  with  wide  reaching  international  relations. 
By  drawing  upon  each  other  by  means  of  long  bills 
designated  as  finance  bills,  these  banks  are  able  to 
dominate  the  exchange  situation. 

All  these  relations  of  international  finance  to  the 
exchange  market  must  receive  consideration. 

2.  Investments. — It  must  be  understood  that  the 
exchange  of  goods  between  countries  involves  not  only 
goods  for  immediate  consumption,  but  represents  fre- 
quently the  transfer  of  capital  from  one  country  to 

90 


IXVESTMEXT  AND  ARBITRAGE  91 

another.  In  the  case  of  the  receiving  country,  imports 
are  not  immediately  offset  by  exports  of  goods.  In- 
stead the  sending  country  receives  various  evidences 
of  indebtedness  or  ownership  in  the  form  of  bonds, 
stocks,  etc.  Such  a  transfer  of  capital  is  character- 
istic of  the  trade  of  all  countries  and  if  there  are  any 
without  it  they  must  be  remote  and  inaccessible  re- 
gions like  Thibet. 

The  effect  of  such  capital  investments  upon  the 
trade  of  a  country^  may  be  considered.  On  the  part 
of  investing  countries  it  first  reveals  itself  in  an  excess 
of  merchandise  exports  over  imports,  and  in  the  coun- 
try where  the  investment  is  made  in  an  excess  of  mer- 
chandise imports  over  exports.  On  this  excess  of 
goods  (capital)  received,  interest  must  be  paid  and 
eventually  perhaps  the  capital  must  be  reimbursed. 
If  we  assume  the  stream  of  investment  to  become 
frozen,  the  importing  country  must  henceforth  pro- 
vide in  its  exports  for  interest  and  capital  repayments. 
Hence  its  exports  of  goods  must  exceed  its  imports. 

But  the  stream  does  not  freeze  up  after  a  single 
investment  transaction  has  taken  place.  It  is  more 
likely  to  continue  for  a  series  of  years.  It  is  naturally 
the  younger  countries  with  undeveloped  national  re- 
sources and  uncultivated  economic  opportunities 
which  are  the  fields  of  such  investment.  In  them  cap- 
ital is  relatively  scarce.  It  commands  a  relatively 
high  return  and  is  inadequate  to  the  task  of  opening 
up  all  the  sources  of  wealth  which  such  countries  con- 
tain.    This  high  rate  of  return  attracts  investors  in 


92  INTERNATIONAL  EXCHANGE 

older  lands  where  capital  is  plentiful  and  obtains  a 
low  rate  of  reward.  The  prospects  of  profits  in 
American  and  Canadian  railroads,  in  Mexican  mines, 
in  Russian  oil  wells,  in  Brazilian  coffee  fields  and  rub- 
ber plantations,  in  Argentine  cattle  ranches,  in  South 
African  gold  fields  and  Australian  sheep  farms,  have 
drawn  from  the  careful  investors  of  Western  Europe 
notably  in  Great  Britain  and  France,  hundreds  of 
millions,  even  billions,  of  dollars  which  have  been  in- 
vested in  these  and  similar  enterprises. 

Concerning  the  value  and  benefit  of  such  invest- 
ments Sir  George  Paish,  perhaps  the  foremost  au- 
thority on  the  subject,  wrote  in  a  report  to  the  United 
States  Monetary  Commission  as  follows: 

Most  of  the  new  countries  are  endowed  by  nature  with 
almost  unlimited  natural  wealth  which  can  be  made  avail- 
able for  consumption  by  the  expenditure  of  a  relatively 
small  amount  of  labor  and  of  capital.  In  proportion  to 
their  natural  resources  the  new  countries  possess  but  a 
small  supply  either  of  labor  or  of  capital  and  they  attract 
supplies  of  both  from  the  older  countries. 

The  construction  of  railways  across  fertile  prairies  opens 
up  great  tracts  of  virgin  country  to  cultivation  at  a  very 
small  expenditure  both  of  effort  and  of  money.  The  rapid 
expansion  of  agriculture  which  ensues  gives  to  the  new 
countries  a  large  amount  of  agricultural  produce  to  ex- 
change for  the  goods  of  the  other  lands  and  to  pay  in- 
terest upon  the  capital  borrowed.  The  introduction  of 
large  sums  of  capital  into  the  new  countries  for  railways 
and  other  purposes  causes,  during  the  period  of  its  intro- 
duction, large  imports  of  manufactured  goods  into  the 
countries  borrowing  the  capital  and  as  a  consequence  the 
imports  of  these  countries  largely  exceed  their  exports. 
Aiter  a  time  the  new  countries  increase  their  production 


INVESTMENT  AND  ARBITRAGE  93 

of  foodstuffs  and  raw  materials  so  largely  that  they  are 
able  to  provide  a  much  larger  proportion  of  the  capital 
they  need  for  themselves  and  they  obtain  the  goods  they 
require  from  other  countries  to  an  increasing  extent  by 
exchange  of  their  own  production  and  less  by  capital  bor- 
rowings. I  calculate  that  capital  wisely  expended  upon 
new  railways  thru  districts  containing  fair  agricultural 
and  mineral  resources  brings  about  an  annual  production 
of  wealth  much  more  than  equal  to  the  total  amount  of 
capital  spent  upon  the  construction  of  the  railways,  a 
rate  of  production  which  could  not  possibly  be  secured 
if  capital  were  not  provided  for  railway  construction. 
The  capital  needed  for  the  direct  development  of  agricul- 
ture, for  mining,  for  house  building,  for  manufactures, 
and  for  retail  trade  is  chiefly  provided  by  the  inhabitants 
of  the  new  countries  themselves .  Nevertheless ,  a  portion 
of  the  capital  required  for  these  purposes  is  also  provided 
by  the  older  countries. 

3.  Foreign  investments  in  the  United  States.— 
During  the  nineteenth  century  the  United  States  of- 
fered the  principal  foreign  field  for  the  investors  of 
Great  Britain,  and  a  few  of  the  Continental  countries. 
Apart  from  a  loan  of  $2,000,000  floated  in  London  in 
1836  by  the  Baltimore  and  Ohio  Railroad,  most  of  the 
investment  of  British  and  other  European  capital  in 
the  United  States  w\^s,  before  1850,  placed  in  state  and 
municipal  bonds.  But  beginning  in  the  fifties  down 
to  the  middle  of  the  eighties  enormous  amounts  of  for- 
eign capital  were  absorbed  in  the  development  of  the 
railway  systems  of  the  United  States.  ]More  recently 
some  of  the  larger  industrial  enterprises  have  drawn 
upon  European  markets  for  capital. 

The  rapid  development  of  the  wealth  of  the  United 


94<  INTERNATIONAL    EXCHANGE 

States  in  the  last  generation  has  supphed  from  local 
sources  most  of  the  capital  needed  for  development  of 
her  enterprises.  Investors  in  Europe  in  search  of 
larger  returns  than  the  home  market  afforded  have 
therefore  turned  their  attention  to  other  fields.  For 
several  years  before  the  Great  War  there  had  been  no 
very  notable  accretions  of  foreign  investment  in  the 
United  States,  but  the  body  of  outstanding  obliga- 
tions inherited  from  earlier  days  was  very  large.  The 
estimate  for  1909,  in  the  report  before  mentioned,  is 
fuller  and  more  complete  than  any  other.  It  may  be 
summarized  as  follows : 

American  Securities  Owned  Abroad. 

Million  Dollars 

Great  Britain    3,500 

France 500 

Germany     1,000 

Holland 750 

Belgium,  Switzerland,  etc 250 

6,000 

As  a  partial  offset  against  this  vast  sum  the  report 
estimated  one  and  a  half  billion  dollars  invested  by 
Americans  in  JNIexico,  Cuba  and  South  America. 

4.  United  States  a  creditor  nation. — These  esti- 
mates were  generally  accepted  at  the  time  as  sub- 
stantially correct  tho  a  few  thought  that  the  total  was 
nearer  four  billion  than  six.  Whatever  the  size  of 
this  investment  in  1909  it  is  probable  that  the  pur- 
chase of  American  securities  on  the  London  market 


INVESTMENT  AND  ARBITRAGE  95 

and  their  transfer  to  Xew  York  with  a  consequent  re- 
duction of  America's  indebtedness  to  foreign  coun- 
tries had  begun  even  before  the  outbreak  of  the  Great 
War.  One  of  the  early  financial  results  of  the  war 
was  the  transfer  of  large  quantities  of  these  securities 
to  American  holders.  In  the  early  stages  of  the  con- 
flict these  securities  were  largely  used  to  meet  Brit- 
ain's demands  for  war  materials. 

Thru  enormous  loans  made  chiefly  by  the  govern- 
ment and  to  some  exten^  by  private  interests  to  Euro- 
pean countries  during  the  war,  the  situation  became 
reversed.  From  being  a  debtor  nation,  the  United 
States  became  a  creditor  nation.  Foreign  securities 
of  all  kinds  are  now  familiar  features  of  our  stock  ex- 
changes and  financial  papers. 

5.  International  securities. — ^^One  result  of  this 
transfer  of  capital  is  to  internationalize  certain  securi- 
ties. They  are  as  familiar  on  the  stock  exchanges  of 
foreign  lands  as  on  those  of  the  land  of  issue.  In  1909 
Sir  George  Paish  tells  us,  the  American  securities  of 
all  sorts  listed  on  the  London  Stock  Exchange  had  a 
nominal  value  of  nine  billion  dollars,  and  according 
to  his  estimate  given  in  the  preceding  paragraph  more 
than  one  third  of  this  amount  was  owned  in  Great 
Britain. 

With  such  a  wide  range  of  securities  bought  and 
sold  on  the  European  exchanges  it  is  evident  that 
there  as  well  as  here  they  could  become  the  object  of 
speculative  transactions  as  well  as  of  * 'permanent"  in- 
vestment.   We  have  now  to  examine  the  important 


96  INTERNATIONAL  EXCHANGE 

effect  of  such  speculative  transactions  upon  the  rates 
of  exchange.  Such  deahngs  are  usually  known  as 
arbitrage  operations. 

6.  What  is  arbitrage? — Arbitrage,  or  as  it  is  some- 
times called,  indirect  exchange,  is  a  term  applied  to 
any  transaction  which  takes  advantage  of  differences 
of  prices  for  the  same  article  in  different  markets. 
Arbitrage  is  thus  defined  in  the  Century  Dictionary: 
"The  calculation  of  the  relative  value,  at  the  same  time 
at  two  or  more  places  of  stocks,  bonds  or  funds  of  any 
sort,  including  exchange,  with  a  view  to  taking  ad- 
vantage of  favorable  circumstances  or  differences  in 
payments  or  other  transactions."  This  definition 
should  include  gold  and,  in  a  general  sense,  any  other 
commodity.  Wheat,  for  example,  may  be  sent  from 
one  place  where  it  is  relatively  cheap  to  another  where 
it  is  relatively  dear;  this  is  arbitraging  in  wheat. 
High  prices  in  one  market  induce  shipments  from 
markets  with  low  prices  and  this  process  constantly 
tends  to  equalize  prices  generally. 

7.  When  arbitrage  is  transacted, — Arbitrage  trans- 
actions are  confined  entirely  to  large  financial  centers^ 
such  as  London,  New  York  and  Paris.  The  work 
calls  for  expert  knowledge  and  a  close  study  of  finan- 
cial conditions,  as  it  is  essential  that  the  arbitrageur 
keep  in  daily,  if  not  hourly,  touch  with  his  foreign 
correspondents,  in  order  that  they  may  be  prepared 
to  carry  out  a  transaction  without  delay. 

A  recent  article  in  the  New  York  Financier  says: 


INVESTMENT  AND  ARBITRAGE  97 

In  conducting  such  operations  it  is  essential  that  the 
banker  shall  be  advised,  thru  the  cable,  of  the  varying 
conditions  of  the  markets  abroad.  In  such  markets  as 
Paris  and  London,  where  the  exchange  transactions  are 
always  large,  rates  often  fluctuate  sharply  and  conditions 
change  frequently.  Consequently,  tho  the  situation  may 
be  favorable  one  day  it  may  suddenly  become  adverse, 
necessitating  some  modification  of  the  method  of  arbi- 
traging.  Moreover,  it  frequently  happens  that  after  a 
successful  negotiation  has  been  effected  by  a  banker  as  the 
result  of  private  information,  his  competitors  may  be  ad- 
vised of  the  favorable  conditions  prevailing  and  they  also 
may  draw  in  a  similar  manner.  Hence  each  operator 
seeks  to  obtain  for  himself  alone  all  possible  information 
regarding  changes  which  are  likely  to  affect  his  business. 
Sometimes  a  banker  may  find,  upon  calculation,  that  it 
will  be  profitable  to  conduct  arbitraging  of  exchange  be- 
tween three  or  more  points;  in  such  cases  the  conditions 
at  each  of  the  points  must  first  be  ascertained  and  calcu- 
lations have  to  be  made  with  the  utmost  care.  Occasion- 
ally in  drawing  bills  the  banker,  in  order  to  take  advantage 
of  arbitraging  operations,  will  transfer  credits,  thru  the 
cable,  from  an  adverse  center  to  a  point  favorable  for  his 
purpose.  Indeed  there  are  very  many  ways  by  which 
arbitraging  can  be  profitably  conducted  by  bankers  having 
the  requisite  facilities  and  the  necessary  skill  for  such  op- 
erations. It  will  be  observed  that  operations  in  arbi- 
traging of  exchange  require  the  services  of  men  of  the 
largest  experience;  hence  the  business  can  be  conducted  to 
advantage  only  in  most  thoroly  equipped  offices. 

8.  Parity, — A  parity  is  the  price  at  which  a  bill 
should  be  quoted  in  order  to  compare  it  with  the  quo- 
tations for  similar  bills  elsewhere.  To  make  this  com- 
parison it  is  of  course  necessary  to  express  every  quo- 
tation in  a  common  form.     Care  must  also  be  taken 

XVIII— 8 


98  INTERNATIONAL  EXCHANGE 

to  bring  quotations  for  long  bills  to  a  demand  basis, 
by  allowing  for  stamps  and  interest. 

If  the  Xew  York  parity  on  Paris  had  been  5.1895,^ 
on  the  old  basis  of  francs  per  dollar  as  against  the 
actual  rate  of  5.16%  in  Xew  York  for  Paris  checks, 
an  opportunity  for  arbitrage  profit  of  2.075  centimes 
per  dollar  would  have  been  offered.  On  $100  this 
would  have  amounted  to  40  cents,  and  on  $48,754.56 
to  $195.  Bankers  who  engage  in  arbitrage  transac- 
tions generally  construct  a  parity  table  for  ready  ref- 
erence between  the  more  important  exchanges.  The 
following  is  an  example  of  such  a  table,  showing  pari- 
ties in  dollars,  francs  and  sovereigns.  Similar  tables 
may  be  made  for  sterling,  marks  and  dollars,  for 
francs,  marks  and  dollars,  etc. 


£1  = 

25.20 

25.21 

25.22 

25.23 

25.24 

25.25 

.$1 

$1 

$1 

$1 

$1 

$1 

^.85 

5.1959 

5.1979 

5.20 

5.2021 

5.2041 

5.2062 

4.851/^ 

5.1932 

5.1953 

5.1973 

5.1994 

5.2014 

5.2035 

4.851/2 

5.1905 

5.1926 

5.1947 

5.1967 

5.1988 

5.2008 

4.853/^ 

5.1879 

5.1900 

5.1920 

5.1910 

5.1961 

5.1982 

1  Attention  is  again  called  to  the  fact  that  a  fixed  exchange  rate  in 
one  country  is  movable  exchange  in  another,  and  both  methods  are 
used  in  arbitrage  transactions  in  order  to  effect  comparison.  Paris 
quotes  francs  per  dollar  (i.  e.  fixed  exchange  to  her  but  movable  ex- 
change to  New  York),  and  it  is  necessary  to  convert  one  or  the  other 
in  order  to  compare. 

The  examples  in  this  chapter  are  based  upon  normal  conditions,  those 
of  pre-war  business,  and  the  tables  and  calculations  are  given  as  they 
were  used  at  that  time.  To  convert  the  table  on  this  page  from  mov- 
able to  fixed  exchange  at  New  York  is  a  matter  of  simple  arithmetic  and 
is  most  easily  done  by  dividing  the  New  York  quotation  for  £  sterling 

4.85 
by  the  London  quotation   for   francs,  as-————,  leading  to  the  result 

Zo.^0 

100  francs  =  .$19,245  -f  or  nearest  commercial  rate  $19.25. 


INVESTMENT  AND  ARBITRAGE  99 

If  the  Xew  York  quotation  for  sterling  was  $4.85 
and  the  London  quotation  for  francs  25.20,  the  Xew 
York  parity  quotation  for  francs  would  be  5.1959;  if 
the  market  rate  differed  from  this  there  would  be  an 
opportunity  for  arbitrage.  Conversely,  given  the  two 
franc  quotations,  the  table  shows  the  parity  of  the 
pound  sterling  in  Xew  York,  or,  given  the  sterling 
and  franc  rate  in  Xew  York,  the  table  shows  the 
parity  quotation  of  francs  in  London.  Intermediate 
rates  can  be  arrived  at  by  interpolation.  For  in- 
stance, in  the  example  given  in  Section  II,  the  sterling 
rate  is  -1.8560,  the  nearest  quotation  in  the  table  is  for 
4.8550 — a  quarter  cent  making  a  difference  of  .0026 
centime  (5.1905 — 5.1879)  in  the  quotation.  There- 
fore,-^X  .0026  =.0010  centime  deducted  from 
5.1906  5.1895.  The  table  is  calculated  by  dividing 
the  value  of  the  sovereign  in  francs  by  its  value  in 
dollars,  thus    ^'^^^^   =  5.1895. 

9.  Parity  in  stocks. — Parity,  when  apphed  to  a 
stock,  means  the  price  which  is  its  equivalent  when 
quoted  in  a  different  market.  For  instance,  the  Lon- 
don price  of  a  stock  exceeds  the  Xew  York  price 
of  the  same  stock  by  about  21^  or  3  per  cent,  after 
the  exchange  rate  and  the  London  method  of  quot- 
ing American  stocks  ($5  to  the  pound)  are  taken 
into  consideration.  With  a  cable  rate  of  4.87l/^  the 
London  parity  of  Xew  York  stock  at  68  would  be 
69.75. 


100  INTERXATIOXAL    EXCHANGE 

■y.r    -^T  •,  London  Quotation  X  rate  of  exch.  or  69.74  X  4-8714        co 

N.  Y.  parity  =  : z =  d8. 

T         J  ..  New  York  quotation  X  5        68  X  5        an  r-'A 

London  parity  =        R,te  of  exchange        ^^  1^^  =  ^^'  '^• 

In  commodities,  the  prices  at  two  different  centers 
are  at  parity  when  the  difference  represents  only  the 
actual  cost  of  transportation,  insurance  and  interest. 

10.  Chain  rule, — Most  of  the  calculations  in  arbi- 
trage transactions  can  be  put  in  the  form  of  simple 
equations,  and  require  only  correct  reasoning  for  their 
solution.  A  quick  tho  mechanical  method  of  calcu- 
lation is  called  the  chain  rule.  It  consists  of  arrang- 
ing the  terms  of  the  exchange  of  the  various  currencies 
under  consideration,  in  such  a  manner  that  the  re- 
quired equivalent,  or  parity,  is  easily  obtained.  A 
study  of  the  following  example  will  make  the  method 
clear : 

Berlin  check  rate  on  New  York  is  95  cents  per  4  marks, 
Berhn  check  rate  on  London  is  20.5  marks  per  £l. 
Find  the  parity  of  the  sovereign  in  New  York. 

How  many  x  =  b  $x  =  £l 

if  b  =  c  £l  =  20.5  marks 

and  c  =  d  Mks.  400  = 
and  d  =  10  X 

1  X  20.5  X  9-5 
"^  ^       =.^.86875 


1  X  400 

The  last  term  is  always  in  the  same  currency  as  the 
unknown  quantity,  or  first  term.  It  will  be  noted  that 
these  quotations  are  arranged  in  such  a  manner  that 
the  denominations  are  in  sequence  like  the  links  of  a 
chain;  hence  the  name.     The  value  of  the  unknown 


INVESTMENT  AND  ARBITRAGE  101 

quantity  (x)  is  then  taken  as  equal  to  a  fraction,  the 
quantities  on  the  right-hand  side  forming  the  numera- 
tor, and  those  on  the  left-hand  side,  the  denominator. 
The  product  of  the  numerator  divided  by  that  of  the 
denominator  will  give  the  required  answer.  "Chain 
rule"  is  applicable  to  all  kinds  of  exchange  and  mer- 
cantile calculations. 

How  many  dollars  (x)  =  £l 

If  the  weight  of  £1  =  123.274  grains  standard  gold 

If  12  grains  of 

standard  gold  =11  grains  of  fine  gold 
And  if  232.2  grains 

of  fine  gold  =  $10 

1  X  123.274  X  11  X  10 

X  =  —-^ =  $4.86656 

1  X  12  X  232.2      ^ 

11.  Simple  arbitrage. — The  rate  of  exchange  be- 
tween two  or  more  places  corresponds  or  tends  to  cor- 
respond. In  a  preceding  section  it  was  shown  how  the 
exchange  rate  between  two  places  is  almost  auto= 
matically  adjusted.  Similar  influences  in  the  form  of 
arbitrage  were  brought  into  operation  to  synchronize 
the  exchange  rates  the  world  over.  There  was  thus  a 
certain  sympathy  or  relation  between  all  foreign  ex- 
change quotations.  The  quotations  in  Xew  York  for 
exchange  on  Berlin  or  Paris  were  largely  influenced 
by  the  price  of  sterling  exchange.  If  the  price  of 
marks  in  Xew  York  should  fall  to  a  point  where  there 
would  be  a  profit  in  an  arbitrage  transaction,  the  de- 
mand for  drafts  on  Berlin,  by  those  who  wish  to  make 
this  profit,  would  almost  immediately  force  the  mark 


102  INTERNATIONAL  EXCHANGE 

quotation  up  again.  Similarly  New  York,  while  a 
debtor  to  England  with  consequent  high  sterling  rates, 
may  be  the  creditor  of  France  or  other  countries  in 
Europe,  and  drafts  on  these  countries  are  remitted  to 
London  and  thus  tend  to  improve  (i.e.,  lower)  the 
rate  of  sterling  exchange.  When  only  three  places 
are  involved,  the  transaction  is  called  simple  arbi- 
trage. 

To  give  a  concrete  case  of  simple  arbitrage:  Sup- 
pose a  banker  in  New  York  had  the  following  data 
before  him: 

London  check  rate  in  New  York.  .  .  .  .$4.8560  per  £ 

Paris  check  rate  in  New  York Fes.  5.16J^  per  $ 

Paris  check  rate  in  London Fes.  25.20  per  £ 

A  brief  calculation  or  a  glance  at  his  table  of  pari- 
ties showed  that  there  was  an  opportunity  for  a  profit- 
able arbitrage  in  francs  between  London  and  New 
York.  He  therefore  sold  a  draft  on  Paris  for  Fes. 
252,000  at  o.lQ'/g  and  with  the  proceeds  bought  a 
draft  for  £10,000  at  4.8560  per  <£,  at  the  same  time 
cabling  his  London  correspondent  to  purchase  a  draft 
for  Fes.  252,000  at  25.20  per  £,  or  better,  and  send  it 
to  Paris  to  the  credit  of  his  account  there.  This  pur- 
chase cost  £10,000  and  was  provided  for  by  a  draft 
for  the  same  amount  remitted  from  New  York.  The 
banker's  position  was  then  as  follows: 

Sale  of  francs  252,000  at  5.16  J^ $48,754.56 

Purchase  of  draft  for  £10,000  at  4.8560  to 
cover  purchase  of  Fes.  252,000  in  London 

at  25.20 48,560.00 

Profit $194.56 


INVESTMENT  AND  ARBITRAGE  103 

AVithout  using  any  of  his  own  capital  and  without 
any  expense  except  the  cost  of  a  cable  and  a  small 
commission  to  his  London  and  Paris  correspondents, 
the  banker  made  a  profit  of  over  $190.  The  result 
of  this  and  similar  transactions  made  at  the  same  time 
by  other  New  York  bankers  would  be  to  lower  the 
New  York  rate  for  francs  by  increasing  the  supply, 
and  to  raise  the  London  rate  by  absorbing  the  sup- 
ply, thus  tending  to  equalize  rates  in  those  interna- 
tional exchange  centers  that  might  have  been  in- 
volved. 

12.  Compound  arbitrage. — The  foregoing  example 
shows  the  simplest  form  of  arbitrage,  but  it  is  typical 
of  such  transactions  as  they  are  normally  carried  out. 
The  banker  might  have  found  it  more  profitable  to 
provide  cover  for  his  draft  on  Paris  by  remitting 
marks  to  Berlin  and  purchasing  his  francs  there,  or 
he  might  have  instructed  his  London  correspondent 
to  purchase  and  remit  a  draft  to  Berhn  with  instruc- 
tion to  the  Berlin  bankers  to  remit  francs  to  Paris. 
In  the  first  instance  he  simply  substitutes  Berlin  for 
London  in  the  transaction,  but  in  the  second  instance 
he  would  operate  both  thru  London  and  Berlin;  four 
places  are  involved,  and  the  transaction  is  known  as 
compound  arbitrage. 

The  study  of  arbitrage  operations  is  both  interest- 
ing and  instructive.  The  following  transaction  will 
bring  out  some  of  the  underlying  principles  more 
clearly : 


104  INTERNATIONAL  EXCHANGE 

PROBLEM:  It  is  desired  to  transfer  $100,000  from  New 
York  to  London  on  the  basis  of  the  data  given  in  the  first 
column.     Which  method  of  remittance  should  be  selected? 

It  is  first  necessary  to  bring  every  quotation  to  a  com- 
mon form;  for  example,  how  many  dollars  equal  £l .  Care 
must  be  taken  to  bring  quotations  for  long  bills  to  a  check 
basis,  allowing  for  stamps,  etc.  The  lowest  parity  in  dol- 
lars will  be  the  cheapest  method  of  remitting  to  London, 
but  the  dearest  return  (remitting  from  London  to  New 
York),  conversely  the  highest  parity,  is  the  dearest  re- 
mittance and  the  cheapest  return: 

Factors:  Calculation.  $  Price  of  £1 

Check 
'A     Berlin   check   in   New   York,  $Xz=:£l  check 

Mk.  4  =  95  cents  1  =  20.5  Mk. 

Berlin  check  in  London,  4  :=  .95 

£  =  Mk.  20.5  


New   York   check   in   Berlin,  X  =  $4.8687                      $4.8687 

$1  =  Mk.  4.21  $X  =  £1  check 

Berlin  check  in  London,  1  z=z  Mk.  20.5 

£l  =  Mk.  20.50  4.21  =  $1 


C     New    York     rate     on     Vienna,  X  =  .^.8693                      $4.8693 

20.30  cents  per  kronen $X  =  £1 

Vienna    check    rate    on    Lon-  £10  =  240.171/2 

don,     240.171/2     kronen     per  1  =  20.30  cents 

£10 ." 

D     London    check    in    New    York,  £10  =  .^.8755                       $4.8755 

$4.8760 $4.8760 

E     Cable   transfers   to   London   in  $4.8795  less  .0028 

New  York,  $4.8795 (7  days'  interest  3%) 

London  discount  rate,  3% $1.8767 

F     London  60-days   draft  in  New  $4.85  plus  .0251 

York,   $4.85 (63  days'  interest  3%) 

and  stamps  .0024  ^.8775 

G     New  York  check  in  Paris,  $X  =  £1  check 

$1  =  Fes.  5.I61/4  1  =  25.2  fcs. 

Paris  check  in  London,  5.1625  =z  $1 

£l  =  Fcs.  25.20  

X=  $4.8813  ^.8813 


INVESTMENT  AND  ARBITRAGE  105 


H 

Paris  check  in  New  York, 

$X  =  £1  check 

$1  =  Fes.  0.15% 

1  =  2o2  fc.  chk. 

Paris  check  in  London, 

5.15625=.$! 

£li=Fcs.  25.20 

X  =  .$i.8872  ^.8872 

A  study  of  the  above  calculation  shows  that  the 
cheapest  method  of  remittance  would  be  thru  Berlin; 
a  pound  sterling  costing  $4.8687.  The  transfer 
could  be  made  either  by  forwarding  to  London  a 
check  on  Berlin  or  by  instructing  the  Berhn  corre- 
spondent to  draw  on  Xew  York  in  favor  of  London. 
The  sterling  equivalent  of  $100,000  on  this  basis 
would  be  £20,539:3:0. 

The  dearest  method  of  remittance  is  via  Paris,  the 
difference  between  the  Paris  and  the  Berlin  rates  be- 
ing 1.85  cents  per  £,  or  $375  on  a  transfer  of 
$100,000.  The  sterling  equivalent  of  $100,000  on  this 
basis  would  be  £20,461 :6 :0.  It  should  be  noted  that 
as  the  Paris  method  of  remittance  is  the  dearest,  it  is 
the  cheapest  return  and  would  therefore  be  selected 
for  the  transfer  of  money  from  London  to  Xew  York. 

13.  Arbitrage  in  gold. — Arbitrage  transactions  in 
gold  and  silver  are  of  a  great  variety  but  they  are  all 
founded  on  the  idea  of  sending  bullion  to  some  point 
where  it  can  be  used  to  buy  exchange  cheaply  on  some 
other  point.  The  one  best  known  of  these  is  the  so- 
called  "triangular  operation,"  in  which  gold  is  shipped 
to  Paris  or  some  other  European  market  for  the  pur- 
pose of  buying  exchange  on  London.  The  process  is 
as  follows :  The  gold  is  shipped  to  Paris,  and  exchange 
on  London    is  there  purchased    with  the    proceeds. 


106  INTERNATIONAL  EXCHANGE 

This  exchange  is  remitted  to  London  for  the  credit  of 
the  American  bank  shipping  the  gold;  the  balance  so 
created  offsetting  a  demand  draft  drawn  by  the  latter 
on  London.  The  following  are  the  details  of  an  ac- 
tual shipment: 

48.500  ounces  bar  gold  .955  fine  at  $20.5684 $997^567 

Freight,  i/g  per  cent $1,247 

Insurance,  41/2  cents  per  $100 450 

Interest  6  days  at  2  per  cent 333 

Assay  office  charge,  4  cents  per  $100 400 

(From  time  gold  is  shipped  to  Paris  until  the  drafts 
on  London  can  be  sold) 

Cartage  and  packing 60 

Com.  in   Paris 250            2,740 

$1,000,307 
Bank  of  France  buys  gold  .995  fine  at  fcs.  3419.81  per  kilo 

(rrr  106.3705  francs  per  troy  ounce) 
48,500  ounces  at  fcs.  106.3705'=  fcs.  5,158,969 
Fcs.  5,158,969  at  25.10  =  £205,536 
£205,536  at  4.8670  =  $1,000,342 

Profit $  35 

The  following  are  conditions  under  which  there  is 
practically  no  profit  or  loss: 

New  York  Exchange  on  London 4.8670 

Paris  Exchange  on  London ,  .25.10 

Money  in  New  York 2% 


REVIEW 

What  is  meant  in  general  terms  by  international  finance  ? 

Describe  the  effect  of  capital  investments  upon  balance  of  ex- 
ports and  imports  of  goods. 

To  what  extent  was  the  United  States  before  the  war  indebted 
to  European  countries  for  capital  investments.^ 

Explain  relation  between  investment  and  arbitrage  operations. 

What  is  arbitrage  and  what  may  it  include? 


INVESTMENT  AND  ARBITRAGE  107 

What  requirements  are  necessary  in  the  work  of  an  arbitra- 
geur r 

Define  a  parity.     Give  an  example. 

What  is  meant  by  parity  in  stocks  ? 

Show,  by  examples,  the  difference  between  simple  and  com- 
pound arbitrage.    What  is  the  essential  idea  in  gold  arbitrage? 


CHAPTER  VII 

FINANXE  BILLS 

1.  Definition  of  a  finance  hilt — A  long  bill  of  ex- 
change drawn  by  a  banker  or  financial  house  in  one 
country  on  a  banker  in  another  against  securities  in 
the  hands  of  the  latter  is  generally  called  a  "finance 
bill."  The  privilege  of  drawing  such  bills  enables 
bankers  to  anticipate  a  change  in  the  rate  of  exchange 
and  also  to  tide  over  a  period  of  high  exchange  which 
otherwise  would  necessitate  a  shipment  of  gold. 
When  properly  used  it  is  an  important  factor  in  in- 
ternational exchange  and  serves  not  only  as  a  cheap 
and  efficient  corrective  to  high  rates,  but  aids  in  the 
development  of  the  production  and  trade  of  the  world 
by  rendering  credit  more  fluid  and  leveling  money 
rates. 

There  is  a  wide  diversity  in  the  definitions  which 
are  given  of  a  finance  bill.  Franklin  Escher  defines 
it  as  "an  unsecured  long  bill  of  exchange  drawn  by  a 
banker  in  one  country  on  a  banker  in  another  coun- 
try and  sold  for  the  purpose  of  raising  money." 
Other  authorities  are  inclined  to  include  all  long  bills 
originating  between  bankers,  whether  secured  or  not. 
The  latter  is  perhaps  the  more  general  understanding 
of  the  term  and  the  following  definition  is  suggested 
as  comprehensive: 

108 


FIXANXE   BILLS  109 

A  finance  bill  is  a  long  bill  of  exchange,  secured  or  other- 
wise, drawn  by  a  banker  in  one  country  on  a  banker  in 
another,  the  funds  for  the  payment  of  which  at  maturity 
must  be  provided  by  the  drawer. 

When  a  Xew  York  banker  had  a  satisfactory  draw- 
ing arrangement  with  his  London  correspondents  he 
was  more  or  less  independent  of  market  conditions, 
and  even  if  there  was  a  scarcity  of  commercial  bills  on 
the  market,  he  w^as  in  a  position  to  create  a  supply  of 
bills  at  a  stated  price.  He  was  reasonably  sure  that 
he  would  be  able  to  buy  exchange  at  a  lower  figure 
to  meet  his  obligations  before  their  maturity,  as  a  high 
rate  of  exchange  brings  out  a  large  supply  of  finance 
bills  resulting  in  a  lowering  of  the  rate.  Mr.  George 
Clare  in  his  book  on  "Foreign  Exchange"  says,  "The 
bidding  need  only  be  raised  a  centime  or  two  to  tap 
an  almost  inexhaustible  source  of  supply — that  of 
bankers'  drafts."  In  other  words,  if  the  remitter 
cannot  obtain  a  ready-made  bill,  he  need  only  pay  a 
little  more  and  have  one  made  to  order. 

2.  Finance  hill  for  New  York  account. — The  most 
common  occasion  for  the  use  of  finance  bills  is  to  an- 
ticipate a  fall  in  the  exchange  rates.  For  instance, 
under  normal  conditions,  during  the  summer  months, 
the  rate  of  exchange  for  sterling  is  generally  high 
in  Xew  York.  It  drops  gradually  until  the  fall, 
when  large  shipments  of  cotton  and  wheat  result  in 
heavy  offerings  of  sterling  exchange.  Before  draw- 
ing a  finance  bill,  it  is  necessary  for  the  Xew  York 
banker  to  make  arrangements    with  the    accepting 


110  INTERNATIONAL  EXCHANGE 

bank  in  London  as  to  the  amount,  terms,  etc.,  of  the 
accommodations.  Such  arrangements  are  general, 
applying  to  a  series  of  transactions,  or  specific,  apply- 
ing to  a  single  transaction  only.  Suppose  the  rate  at 
the  end  of  August  some  years  ago  was  4.88  for  de- 
mand bills,  and  a  banker,  A,  desirous  of  anticipating 
the  probable  drop  in  exchange  in  the  fall,  had  ar- 
ranged wilh  his  London  correspondent,  B,  against 
securities  deposited  with  him,  for  a  credit  of  £10,000 
by  way  of  a  sixty-day  draft  on  London.  A  would 
draw  a  draft  on  B  at  sixty  days  for  £10,000,  which 
he  could  either  ( I )  sell  in  New  York  at  the  sixty-day 
rate  for  bills  or  else  (2)  send  to  London  to  be  dis- 
counted and  placed  to  his  credit  there,  and  then  sell 
his  own  sight  drafts  against  this  credit.  In  either 
case,  he  would  have  the  use  of  the  proceeds  in  New 
York  until  the  maturity  of  the  bill,  when  he  must  be 
prepared  to  place  funds  with  B  to  meet  it. 

3.  Method  of  using  finance  bills. — It  will  be  noticed 
that  B  did  not  advance  any  money;  he  lent  his  name 
to  A  and  the  London  discount  market  provided  the 
funds.  The  advantages  and  disadvantages  of  this 
procedure  may  be  summed  up  in  illustrations: 

1.  A  would  sell  his  sixty-day  bill  in  New  York  if  he 
could  obtain  $4.8523  per  pound  sterling  or  better.  This 
rate  is  arrived  at  as  follows: 

Demand  rate  for  sterling 468. 

1  Less,  63  days'  interest  at  3%    (being  the  London  mar- 
ket rate  for  prime  bankers'  bills) 2.527 

1  Prior  to  the  war,  interest  and  stamps  used  to  be  calculated  on  the 
basis  of  $485  to  the  £100,  but  owing  to  the  wide  fluctuation  they  are  now 
frequently  calculatc^l  on  the  actual  rate  itself. 


FINANCE   BILLS  111 

Stamps  1/20  of  1% 244         2.771 

Per  £100 485,229 

or  $4.8523  per  pound  sterling. 

The  sixty-days  bills  for  £10,000  should  therefore  net  him ^8,522.90 

A  employed  these  funds  in  New  York  for  sixty  days  at  4%, 

earning     323.49 

$48,846.39 
Seven  days  before  the  bill  matured  A  purchased  a  demand 
draft  for-  £  10,000  which  he  forwarded  to  London  to  provide 
for  the  payment  of  the  bill.  By  this  time  exchange  had 
fallen  as  he  anticipated  and  was  at  4.85,  so  that  he  was 
able  to  buy  the  covering  draft  for 48,500.06 

A's  profit    (from  which  must  be   deducted   B's   commission  of 

probably  1/3  of  1%)  was  therefore .$      366.39 


There  is,  of  course,  the  risk  that  exchange  might 
not  fall  at  the  end  of  October  as  anticipated,  or  that 
the  interest  rates  in  Xew  York  might  not  be  main- 
tained above  3  per  cent. 

2.  If  A  sent  the  sixty-day  bill  to  London  and  immedi- 
ately sold  a  demand  draft  against  the  remittance,  the 
transaction  would  work  out  as  follows: 

Amount  of  60-days  draft £10,000.00 

Less  interest  at  37f £51.781 

Less  stamps,  1/20  of  1% 5.00  56.78 

Net  proceeds  in  London £  9,943.22 

A  would  thus  be  in  a  position  to  sell  his  demand 
draft  for  the  above  amount  and  provide  himself  with 
funds  in  Xew  York,  £9,943.22  at  $4.88=$48,522.90, 
the  same  amount  as  realized  in  ( 1 )  by  the  sale  of  the 
sixty-days  bills  itself  in  Xew  York. 

The  net  proceeds,  £9,943.22,  are  taken  as  the 
amount  of  the  demand  draft  for  illustrative  purposes ; 
in  actual  practice  the  draft  would  have  been  drawn  in 


112  INTERNATIONAL  EXCHANGE 

round  figures,  £10,000.     The  same  result  would  be 
obtained,  thus: 

£10,000  demand  draft  realized  in  New  York $48,800.00 

From  which  must  be  deducted  the  London  charges   for  in- 
terest and  stamps,  £56.78  at  $4.88 277.09 


$48,522.91 

If,  at  the  maturitj^  of  a  finance  bill,  it  was  not  con- 
venient to  collect  and  remit  the  relative  loan,  it  was 
generally  possible  to  provide  the  necessary  funds  to 
meet  the  maturing  bill  by  the  sale  of  another  bill. 

4.  Loan  of  a  finance  hill. — The  last  example  shows 
that  the  New  York  banker  assumed  the  risk  of  there 
being  a  rise  in  the  rate  of  exchange  before  the  trans- 
action had  been  completed  and  the  acceptance  in  Lon- 
don retired  by  a  sterling  remittance. 

So  far  as  the  actual  borrower  was  aware,  the  loan 
is  an  ordinary  loan  in  American  currency ;  he  had  no 
means  of  knowing  that  there  is  any  question  of  for- 
eign exchange  connected  with  the  transaction.  He  has 
borrowed  say  $50,000  at  two  months  at  4  per  cent, 
but  with  his  bank  the  case  is  different.  It  loaned  the 
proceeds  of  a  sixty-day  bill  on  London  and  at  its 
maturity  would  have  to  purchase  a  demand  bill  or 
cable  for  £10,000  at  the  current  rate  of  exchange. 
The  price  paid  for  the  bill  determines  the  gain  or  loss 
in  the  transaction.  If  exchange  rates  went  down  as 
anticipated  a  good  profit  on  the  transaction  might  be 
made,  but  if  the  rate  rose,  the  price  to  be  paid  might 
mean  an  even  break  because  of  the  wiping  out  of  all 
profit,  or  if  the  rate  went  high  enough,  an  actual  loss. 


FINANCE   BILLS  113 

Bank  A  could  eliminate  this  risk  by  loaning  the  bill 
of  exchange  instead  of  the  dollar  proceeds,  and  charg- 
ing a  commission  instead  of  a  fixed  rate  of  interest; 
the  borrower  thus  assuming  the  risk  of  a  rise  in  the 
exchange  rate.  The  borrower  in  this  case,  instead  of 
receiving  a  loan  of  $50,000,  would  be  handed  A's 
sixty-day  draft  on  London  for  £10,000.  This,  he 
would  immediately  sell  for  dollars,  but  when  the  time 
for  repayment  came,  he  would  have  to  pay  back  not 
dollars  but  a  demand  draft  for  £10,000  which  he 
would  have  to  purchase  at  the  current  rate  of  ex- 
change. The  banker  makes  a  commission  of  about 
one-half  of  one  per  cent  for  sixty  days  and  runs  no 
risk  in  the  matter  other  than  the  loaning  risk  to  his 
customer. 

5.  A  finance  hill  on  London  account. — Another 
form  of  finance  bill  was  created  when  a  London 
banker,  desirous  of  taking  advantage  of  a  high  rate  of 
interest  in  Xew  York,  instructed  his  correspondent 
to  draw  on  him  for  £10,000  at  sixty  days  and  lend 
the  proceeds  on  the  Xew  York  market.  This  the 
New  York  banker  did  and  sold  the  bill  in  New  York, 
investing  the  money.  Neither  banker  employed  his 
own  money  in  the  operation,  the  money  being  pro- 
vided by  the  London  market  where  the  bill  was  dis- 
counted. At  the  maturity  of  the  loan,  the  London 
bank  was  placed  in  funds  to  meet  its  acceptance  by 
tjie  New  York  banker,  or  if  conditions  continued 
favorable  the  amount  might  be  either  renewed  or  re- 
loaned  in  New  York.     A  transaction  of  this  nature 


114  INTERNATIONAL  EXCHANGE 

may  have  been  entirely  on  the  account  of  and  at  the 
risk  of  the  London  banker,  or  it  may  have  been  on 
joint  account,  in  which  case  both  the  risk  and  the 
profit  were  shared. 

6.  Other  uses  of  finance  hills. — Finance  bills,  both 
secured  and  unsecured,  may  be  drawn  regardless  of 
the  conditions  of  interest  or  exchange,  purely  for  the 
sake  of  raising  money.  As  a  rule,  finance  bills  have 
a  reasonable  excuse  for  their  existence.  It  may  be 
objected  that  this  is  a  way  of  getting  money  which 
might  be  easily  abused,  but  in  practice  this  does  not 
happen.  The  London  market  is,  at  all  times,  uncan- 
nily in  touch  with  the  position  of  both  the  drawer  and 
acceptor  and  any  attempt  on  the  part  of  either  to  issue 
this  class  of  bill  beyond  what  he  is  legitimately  entitled 
to  on  the  basis  of  his  business  or  financial  standing,  is 
promptly  nipped  in  the  bud,  first,  by  demanding 
higher  rates  and  finally,  by  refusing  to  take  the  paper. 
Either  action  is,  of  course,  detrimental  to  the  credit 
of  the  party  concerned,  and  bankers  and  others  who 
operate  in  finance  bills  are  most  careful  to  leave  a  large 
margin  for  safety  in  their  use  of  the  very  sensitive  dis- 
count market.  It  is  plain  from  the  above  explana- 
tions that  when  many  of  these  finance  bills  are  drawn 
on  London  they  will  have  a  tendency  to  lower  the 
rate  of  exchange  by  increasing  the  supply  of  sterling 
bills  on  the  market. 

In  these  illustrations,  London  and  New  York  have 
been  referred  to  under  normal  conditions;  finance 


FINANCE   BILLS  115 

bills,  of  course,  obtain  between  other  countries  but  to 
a  much  less  degree. 

7.  Forward  exchange. — Operations  in  'forward 
exchange"  have  several  points  in  common  with  finance 
bills;  both  anticipate  fluctuations  in  the  rate  of  ex- 
change and  both  involve  a  large  element  of  risk.  In 
its  simpler  and  more  commercial  form,  forward  ex- 
change or  "futures,"  as  it  is  sometimes  called,  is  a  term 
used  to  express  the  buying  or  selling  of  foreign  ex- 
change for  future  delivery.  For  instance,  in  July,  a 
manufacturer  in  Canada  accepts  an  order  for  goods  to 
be  manufactured  and  shipped  to  England  before  Oc- 
tober 15.  Knowing  from  experience  that  a  change 
in  the  rate  of  exchange  in  October  might  make  serious 
inroads  into  his  profits,  he  asks  his  bank  to  quote  him 
a  rate  for  the  amount  of  his  shipment,  and  contracts 
to  deliver  the  bills  of  exchange  to  the  bank  in  October. 
In  this  way  the  rate  is  definitely  fixed,  and  the  risk  of 
a  falling  rate  is  eliminated. 

The  bank  can  protect  itself  in  two  ways ;  by  selling 
its  own  bills  to  fall  due  in  October  in  London,  or  by 
selling  London  exchange  for  future  delivery.  As  far 
as  the  obligation  is  concerned  both  cases  amount  to  the 
same  thing,  except  that  in  the  latter  no  money  trans- 
action is  involved.  The  decision  of  the  bank  is  gov- 
erned by  the  rate  of  interest  obtaining  in  London  in 
July.  It  is  obvious  that  dealing  in  forward  exchange 
is  not  necessarily  based  on  an  actual  prospective  trans- 
action. 

Frankhn  Escher,  in  his  book,  "The  Elements  ^ 


116  INTERNATIONAL  EXCHANGE 

Foreign  Exchange,"  in  reference  to  the  making  of 
money  in  dealing  in  "futures,"  says: 

As  a  means  of  making — or  of  losing — money,  in  the  for- 
eign exchange  business ,  dealing  in  contracts  for  the  future 
delivery  of  exchange  has,  perhaps,  no  equal.  And  yet 
trading  in  futures  is  by  no  means  necessarily  speculation. 
There  are  at  least  two  broad  classes  of  legitimate  operation 
in  which  the  buying  and  selling  of  contracts  of  exchange 
for  future  delivery  plays  a  vital  part. 

Take  the  case  of  a  banker  who  has  bought  and  remitted 
to  his  foreign  correspondent  a  miscellaneous  lot  of  foreign 
exchange  made  up  to  the  extent  of  one-half,  perhaps,  of 
commercial  long  bills  w4th  documents  deliverable  only  on 
"payment"  of  the  draft.  That  means  that  if  the  whole 
batch  of  exchange  amounted  to  £50,000,  £25,000  of  it 
might  not  become  an  available  balance  on  the  other  side 
for  a  good  while  after  it  had  arrived  there — not  until  the 
parties  on  whom  the  "payment"  bills  were  drawn  chose  to 
pay  them  off  under  rebate.  The  exchange  rate,  in  the 
meantime,  might  do  almost  anything,  and  the  remitting 
banker  might,  at  the  end  of  thirty  or  forty -five  days,  find 
himself  w^ith  a  balance  abroad  on  which  he  could  sell  his 
checks  only  at  very  low  rates. 

To  protect  himself  in  such  a  case  the  banker  would,  at 
the  time  he  sent  over  the  commercial  exchange,  sell  his  own 
demand  drafts  for  future  delivery.  Suppose  that  he  had 
sent  over  $25,000  of  commercial  "payment"  bills.  Un- 
able to  tell  exactly  when  the  proceeds  w^ould  become  avail- 
able, the  banker  buying  the  bills  would,  nevertheless,  pre- 
sumably have  had  experience  w^ith  bills  of  the  same  name 
before,  and  would  be  able  to  form  a  pretty  accurate  esti- 
mate as  to  when  the  drawees  would  be  likely  to  "take  them 
up"  under  rebate.  It  w^ould  be  reasonably  safe,  for  in- 
stance, for  the  banker  to  sell  futures  as  follows:  £5,000 
deliverable  in  fifteen  days,  £10,000  deliverable  in  thirty 
days,  £10,000  deliverable  in  forty-five  to  sixty  days. 
Such  drafts  on  being  presented  could  in  all  probability 


FINANCE   BILLS  117 

be  taken  care  of  out  of  the  prepayments  on  the  commer- 
cial bills. 

By  figuring  with  judgment ,  foreign  exchange  bankers  are 
often  able  to  make  substantial  profits  on  operations  of  this 
kind.  An  exchange  broker  comes  in  and  offers  a  banker 
here  a  lot  of  good  "payment"  commercial  bills.  The 
banker  finds  that  he  can  sell  his  own  draft  for  delivery  at 
about  the  time  the  commercial  drafts  are  apt  to  be  paid 
under  rebate,  at  a  price  which  means  a  good  net  profit. 
The  operation  ties  up  capital,  it  is  true,  but  is  practically 
without  risk.  Not  infrequently  good  commercial  "pay- 
ment" bills  can  be  bought  at  such  a  price  and  bankers' 
futures  sold  against  them  at  such  a  price  that  there  is  a 
substantial  profit  to  be  made. 

The  other  operation  is  the  sale  of  bankers'  futures,  not 
against  remittances  of  actual  commercial  exchange  but 
against  exporters'  futures.  Exporters  of  merchandise  fre- 
quently quote  prices  to  customers  abroad  for  shipment  to 
be  made  in  some  following  month,  to  establish  which  fixed 
price  the  exporter  has  to  fix  a  rate  of  exchange  definitely 
with  some  banker.  *T  am  going  to  ship  so-and-so ,  so  many 
tubs  of  lard  next  May,"  says  the  exporter  to  the  banker, 
"the  drafts  against  them  will  amount  to  so-and-so  much. 
^^^lat  rate  will  you  pay  me  for  them — delivery  next  May?" 

The  banker  knows  he  can  sell  his  own  draft  for  May 
delivery  at,  say,  4.87.  He  bids  the  exporter  4.86^  2  for  his 
lard  bills,  and  gets  the  contract.  Without  any  risk  and 
without  tying  up  a  dollar  of  capital  the  banker  has  made 
one-half  cent  per  pound  sterling  on  the  whole  amount  of 
the  shipment.  In  ^lay,  the  lard  bills  will  come  in  to  him, 
and  he  will  pay  for  them  at  a  rate  of  4 .86j^,  turning  around 
and  delivering  his  own  draft  against  4.87. 

Selling  futures  against  futures  is  not  the  easiest  form  of 
foreign  exchange  business  to  put  thru,  but  when  a  house 
has  a  large  number  of  commercial  exporters  among  its 
clients  there  are  generally  to  be  found  among  them  some 
who  want  to  sell  their  exchange  for  future  delivery.  As  to 
the  buyer  of  the  banker's  ^'future,"  such  a  buyer  might 


118  INTERNATIONAL  EXCHANGE 

be,  for  instance,  another  banker  who  had  sold  finance  bills 
and  wanted  to  limit  the  cost  of  **covering"  them. 

The  foregoing  examples  of  dealing  in  futures  are  merely 
examples  of  how  futures  may  figure  in  every-day  exchange 
transactions.  Like  operations  in  exchange  arbitrage,  there 
is  no  limit  to  the  number  of  kinds  of  business  in  which 
* 'futures"  may  figure.  They  are  a  much  abused  institu- 
tion, but  are  a  vital  factor  in  modern  methods  of  transact- 
ing foreign  exchange  business. 

REVIEW 

What  is  a  finance  bill  ? 

Show,  by  an  illustration,  what  arrangements  a  New  York 
banker  makes  with  a  London  bank  before  drawing  a  finance  bill. 

Give  an  example  of  how  a  finance  bill  on  London  account  is 
created. 

How  does  the  London  market  prevent  either  a  drawer  or  an  ac- 
ceptor of  finance  bills  from  issuing  them  beyond  the  amount  to 
which  they  are  legitimately  entitled? 

Describe  an  operation  in  forward  exchange. 


CHAPTER  VIII 

RATES  OF  INTEREST 

1.  Interest  an  important  factor  in  exchange  quota- 
tions,— The  rate  of  interest  at  which  the  difference 
between  long  and  short  bills  is  calculated  is  based  on 
the  prevailing  rate  of  the  country  on  which  the  bill  is 
drawn.  This  would  not  materially  affect  the  situa- 
tion if  the  rates  of  interest  were  uniform  all  over  the 
world,  but  rates  of  interest  in  different  financial  cen- 
ters vary  considerably  and  these  differences  have  an 
important  bearing  on  exchange.  Under  normal  con- 
ditions, international  money  and  credit  circulate  most 
freely  in  the  most  attractive  channels,  and  a  rise  in  the 
interest  rate  in  a  foreign  market  will  accelerate  the 
flow  of  outside  capital  to  that  point,  while  a  fall  in  the 
rate  of  interest  will  retard  it.  So,  while  demand  and 
supply  govern  rates  of  exchange,  the  rates  of  interest 
at  home  and  abroad  react  on  these  influences  and 
affect  demand  and  supply.  Their  combined  effect 
causes  the  rates  of  exchange  to  fluctuate  from  day  to 
day  and  thus  the  floating  capital  of  the  world  is  at- 
tracted from  one  center  to  another. 

2.  Long  hills. — When  we  say  that  exchange  rates 
between  two  countries  usually  fluctuate  between  the 
specie  points,  we  refer  only  to  the  rate  for  demand  or 
sight  bills.     This  is  sometimes  called  the  pure  rate  of 

119 


120  INTERNATIONAL  EXCHANGE 

exchange  as  it  involves  no  time  element  except  that 
required  for  the  actual  transmission  of  the  draft. 

Assuming  that  the  rate  at  Xew  York  for  a  sight 
bill  or  check  on  London  is  4.8725  how  would  the  value 
of  a  sixty-days  sight  bill  be  ascertained?  As  pay- 
ment in  the  latter  case  is  deferred  for  sixty-three  days 
(60  days  +  3  days  grace)  it  will  be  worth  less  than  a 
demand  bill  by  the  interest  for  63  days  at  the  London 
rate.  The  calculation  is  based  on  the  London  rate  of 
interest,  because  the  holder  of  the  bill  in  London  can 
always  discount  it  at  the  prevailing  rate. 

Assuming  that  the  market  discount  rate  for  prime 
bills  is  3  per  cent,  the  rate  for  a  sixty-days  bill  would 
be  arrived  at  as  follows: 

Demand  rate  per  £100 $487.25 

Less  63-day s  interest 2.52 

Stamp  1/20 24  2.76 

$484.49 

corresponding  to  the  nearest  commercial  rate,  the  fig- 
ure would  be  $4,8450. 

If,  therefore,  we  know  the  rate  of  interest  prevail- 
ing in  foreign  markets  and  the  stamp  taxes  imposed 
by  foreign  countries,  the  rate  for  any  long  bill  can 
readily  be  computed  from  the  demand  rate. 

3.  Bank  rate, — In  London,  the  bank  rate  is  the 
minimum  rate  at  which  the  Bank  of  England  will  dis- 
count prime  three  months'  bills  or  advance  money 
against  approved  securities.  This  rate  has  a  direct 
relation  to  the  foreign  exchange  rate  and  the  move- 


RATES  OF  INTEREST  121 

ment  of  gold.  An  increase  in  the  rate  would  raise 
the  value  of  money  and  attract  gold  from  foreign  cen- 
ters ;  the  lowering  of  the  rate  would  tend  to  lower  the 
value  of  money  and  cause  its  withdrawal.  The  Bank 
of  England  sometimes  insures  the  effectiveness  of  the 
rate  by  borrowing  money  in  the  open  market,  thus 
denuding  it  of  supplies.  The  Bank  of  England  has 
been  governed  in  its  action  in  raising  or  lowering  the 
rate  by  the  relation  which  its  reserve  of  gold  bore  to 
its  deposits.  This  proportion  was  seldom  allowed  to 
fall  below  30  per  cent,  while  it  sometimes  rose  above 
50  per  cent,  the  average  normal  condition  was  about 
43  per  cent.  The  importance  of  keeping  the  gold 
reserve  intact  was  appreciated  and  it  was  most  im- 
portant to  the  country,  as  the  Bank  of  England  is 
primarily  a  bankers'  bank  and  in  a  great  measure 
controlled  the  gold  reserve  of  all  the  British  banks. 

In  Paris,  the  bank  rate  is  that  fixed  by  the  Bank  of 
France,  in  Berlin  that  of  the  Imperial  Bank.  In  Xew 
York,  the  bank  rate  is  the  uniform  rate  of  the  banks 
as  distinguished  from  the  varying  rates  of  the  other 
lenders. 

4.  Market  rate, — The  market  rate  of  discount,  also 
known  as  the  open  market  rate  or  private  rate,  in  con- 
tradistinction to  the  official  or  bank  rate,  is  the  rate 
charged  by  bankers,  bill  brokers  and  others  discount- 
ing bills  of  exchange.  Because  of  competition  it  is 
usually  a  little  lower  than  the  bank  rate,  but  as  a  rule 
follows  the  latter  very  closely. 

Clean  bills  drawn  upon  bankers  are  discounted  at 


122  INTERXATIOXAL  EXCHANGE 

the  private  rate,  while  those  drawn  upon  firms  in  good 
standing  are  generally  discounted  at  about  ^  per  cent 
above  the  private  rate. 

The  Bank  of  England  rate  governs  the  rate  of  in- 
terest paid  on  deposits  by  the  London  joint  stock 
banks.  This  rate  is  generally  1^  per  cent  below  the 
Bank  of  England  rate. 

5.  Retirement  rate. — In  cases  where  bills  have 
documents  attached,  with  instructions  to  accept  pay- 
ment "under  a  rebate  of  ^/o  per  cent  above  the  rate  of 
interest  allowed  on  deposits  by  joint  stock  banks,"  if 
the  bank  rate  were  4  per  cent  the  deposit  rate  would 
be  2^/2  per  cent  and  the  rebate  rate  three  per  cent. 
This  is  known  as  the  "retirement"  rate,  and  the  bill  is 
said  to  be  taken  up  "under  rebate"  in  order  that  the 
drawer  may  obtain  possession  of  the  relative  goods  be- 
fore maturity.  Such  bills  are  known  as  D/P  bills 
(documents  on  payment)  and  are  not  discounted  by 
English  banks. 

6.  Iviportance  of  the  Bank  of  England  rate, — The 
movement  of  gold  from  one  country  to  another,  or 
even  the  probability  of  such  a  movement,  is  an  im- 
portant factor  in  determining  the  rates  of  exchange 
on  the  countries  affected.  London,  owing  to  the  ex- 
treme sensitiveness  of  the  Bank  of  England  rate  to 
gold  movements  in  normal  times  is  particularly  inter- 
ested in  its  discount  rate.  Suppose,  for  instance, 
that  in  normal  times,  on  account  of  a  low  sterling  rate, 
Xew  York  commences  to  import  gold  from  London. 
The  Bank  of  England,  seeing  its  stock  of  gold  be- 


RATES  OF  INTEREST  1^23 

coming  too  low,  raises  its  official  rate  of  discount, 
which  is  the  term  applied  to  the  minimmn  rate  at 
which  it  will  discount  approved  bills.  The  London 
market,  whose  rate  is  usually  a  little  lower  than  that 
of  the  Bank  of  England,  will  probably  rise  in  sym- 
pathy, but  if  it  does  not  do  so  the  Bank  of  England, 
by  borrowing  money  in  the  open  market,  will  force 
up  the  rate  and  the  effect  of  dear  money  is  soon  ap- 
parent. The  foreign  monej^  markets,  in  order  to  take 
advantage  of  the  higher  interest  rate  in  London,  will 
allow  their  balances  to  accumulate  there  for  invest- 
ment or  will  purchase  bills  on  London.  British  mer- 
chants will  decrease  their  imports  and  increase  their 
exports.  In  this  way  the  balance  of  payments  grad- 
ually swings  around  again  in  favor  of  Great  Britain. 
Exports  of  gold,  therefore,  cause  sterling  rates  in 
Xew  York  and  elsewhere  to  stiffen  and,  if  the  high 
rate  is  maintained  sufficiently  long,  it  will  check  the 
export  and  eventually  induce  an  inflow  of  gold  to 
London.  Thus,  the  reserves  of  the  Bank  of  England 
will  again  become  normal  arid  the  rate  will  then  be 
reduced.  The  importance  of  the  Bank  of  England 
rate  in  controlling  international  exchange  and  gold 
movements  cannot  be  overestimated,  and  its  effects 
are  so  far  reaching  that  monetary  conditions  thruout 
the  world  are  directly  or  indirectly  influenced  by  it. 
The  rate  is  fixed  by  the  directors  of  the  bank  on 
Thursday  of  each  week  and  tho  as  few  changes  as 
possible  are  made,  the  publication  of  the  rate  is  al- 
wavs  a  matter  of  interest  to  the  financial  world. 


124  INTERNATIONAL  EXCHANGE 

The  Bank  of  England  is,  at  all  times,  fully  pre- 
pared to  make  advances  against  satisfactory  collat- 
eral, or  to  rediscount  approved  acceptances  at  its 
minimum  rate  of  discount.  Facilities  of  this  nature 
naturally  create  a  feeling  of  stability  and  confidence 
among  the  English  bankers,  and  the  protection  and 
assistance  at  their  command  in  times  of  emergency 
enable  them  to  conduct  their  business  on  a  smaller 
cash  reserve  basis  than  is  possible  by  bankers  in  coun- 
tries without  similar  protection. 

7.  What  the  Bank  of  England  rate  effects, — It  has 
been  said  that  the  Bank  of  England  rate  acts  in  nor- 
mal times  as  a  barometer  of  the  financial  condition  of 
the  world  and  any  features  of  political  or  economic 
significance  are  reflected  by  its  course. 

Mr.  A.  W.  Margraff^  in  pointing  out  the  impor- 
tance attaching  to  the  fluctuation  of  the  discount  rate 
of  the  Bank  of  England  states  the  various  results 
which  are  effected  as  follows: 

The  discount  rate: 

1 .  Establishes  the  minimum  rate  at  which  the  Bank  of 
England  will  discount  acceptable  paper. 

2.  Fixes  the  rate  of  interest  allowed  by  London  joint- 
stock  companies  on  short  deposits,  since  this  rate  is  one 
and  one-half  per  cent  under  the  Bank  of  England  rate. 

3.  Determines  the  rate  of  interest  allowed  by  London 
bankers  on  cash  balances  to  the  credit  of  foreign  corre- 
spondents, keeping  active  accounts  with  them,  in  so  much 
that  this  rate  is  usually  }/2  to  1%  below  the  Bank  rate. 

4 .  Serves  also  to  fix  the  rate  of  interest  charged  on  cash 

1  "International  Exchange"  by  A.  W.  Margraff. 


RATES  OF  INTEREST  125 

overdrafts,  on  running  accounts,  as  debit  balances  are 
generally  subject  to  the  Bank  rate,  or  Yi  to  1%  above, 
according  to  agreement. 

5.  Establishes  the  open  market  discount  rate  in  Great 
Britain  at  which  private  bankers,  London  joint  stock  com- 
panies and  discount  houses  will  discount  paper  for  local 
or  foreign  account,  the  rate  ordinarily  being  from  34  to 
3^2%  below  the  Bank  rate. 

6.  Governs  the  "Retirement  Rate  of  Discount"  on  docu- 
mentary payment  bills,  which  is  the  rate  of  interest  re- 
bated to  the  drawee,  or  acceptor  of  a  documentary  pay- 
ment bill  for  the  time  from  the  date  of  retirement  or  pre- 
payment to  the  date  of  maturity  of  the  bill,  this  rate  being 
Y'f/o  above  the  rate  of  interest  allowed  by  London  joint- 
stock  companies  for  short-time  deposits,  which  rate  is 
based  on  the  Bank  rate  as  above. 

7.  Affects  the  value  of  all  international  bills  of  exchange 
as  an  advance  in  the  Bank  rate  either  advances  the  rate  of 
exchange  for  a  demand  sterling  draft  in  a  foreign  country 
or  depreciates  the  worth  of  a  long  time  sterling  bill,  as 
the  interest  rate  for  credit  balances  and  the  discount  rate 
for  long  time  paper  are  indirectly  dependent  upon  the 
Bank  rate. 

8.  Has  the  power  of  protecting  the  gold  reserve  held  by 
the  Bank  of  England  and  of  checking  any  protracted 
movements  of  gold  importations  by  foreign  nations,  in  so 
much  as  an  advance  in  the  Bank  rate  adjusts  the  rates  of 
foreign  exchange  to  a  point  where  operations  of  this  nature 
become  unprofitable. 

9.  Invites  and  attracts  the  deposits  of  foreign  banks 
with  London  correspondents  as  an  advance  in  the  Bank 
rate  to  a  figure  in  excess  of  the  earning  capacity  at  home 
induces  continental  money  lenders  to  seek  the  London 
market  for  investment  of  their  funds. 

10.  Indirectly  has  a  tendency  to  depress  or  advance  the 
values  of  stocks  listed  on  the  New  York  Stock  Exchange — 
an  advance  in  the  Bank  rate  causing  a  decline  in  stock 
values,  and  a  reduction  in  the  Bank  rate  usually  having 


U6  INTERNATIONAL  EXCHANGE 

the  opposite  effect,  because  the  values  of  stocks  are  largely 
dependent  upon  the  monetary  conditions  obtaining  in  New 
York,  and  as  New  York  bankers  in  periods  of  stringency 
nowadays  resort  to  relieve  the  situation  by  issuing  Finance 
Bills  drawn  upon  English  bankers,  the  Bank  of  England 
rate  indirectly  either  facilitates  or  precludes  their  course 
of  action. 

REVIEW 

What  effect  has  the  interest  rate  on  exchange  quotations  ? 

What  is  the  bank  rate  in  London  and  what  relation  has  it  to 
the  foreign  exchange  rate  and  the  movement  of  gold?  What  is 
the  bank  rate  in:  France^  Berlin,  New  York? 

Discuss  the  market  rate  of  discount;  the  retirement  rate. 

Show  how  the  Bank  of  England  rate  is  an  important  factor  in 
determining  rates  of  exchange. 


CHAPTER  IX 

BILLS  OF  EXCHANGE 

1.  Bills  of  eoocliange, — It  has  already  been  indicated 
that  the  fundamental  purpose  of  a  draft  or  bill  of  ex- 
change is  to  settle  debts  and  thus  avoid  the  necessity  of 
shipping  gold.  To  satisfy  a  debt  in  one  country  by 
offsetting  the  amount  against  a  debt  due  in  another 
country,  leaving  only  the  difference,  if  any,  to  be  re- 
mitted in  gold,  is  no  less  effective  a  means  of  payment 
than  a  double  shipment  of  money,  and  is  obviously 
more  economical.  In  this  way,  the  difference  or  bal- 
ance of  payments  as  it  is  called,  is  settled  by  the  debtor 
nation  shipping  gold  or  arranging  a  postponement  of 
2)ayment  by  means  of  finance  bills  or  other  corrective 
transactions. 

A  check  is  merely  a  demand  bill  of  exchange  drawn 
on  a  bank.  Bills  of  exchange  or  drafts,  as  we  shall 
now  call  them,  assume  a  variety  of  forms  and  tenor, 
but,  no  matter  what  their  ciu'rency  or  form,  the  un- 
derlying principle  is  the  same,  namely,  that  of  a  cred- 
itor drawing  a  draft  upon  an  actual  or  constructive 
debtor. 

•  Bills  of  exchange  can  be  broadly  divided  into  two 
classes  according  to  their  currency,  known  as  short 
and  long  exchange. 


128  INTERNATIONAL  EXCHANGE 

Short  exchange  includes  cable  transfers,  checks, 
bank  drafts  and  sight  or  demand  drafts.  Travelers' 
checks,  money  orders  and  other  forms  of  non-com- 
mercial remittances  come  under  this  heading. 

Long  exchange  includes  all  drafts  with  a  currency 
of  eight  days  or  over,  such  as  thirty  and  sixty-day 
commercial  bills  and  bankers'  long  bills. 

2.  Sight  drafts. — Checks  and  demand  or  sight 
drafts,  whether  drawn  on  a  bank  or  a  commercial 
house,  have  no  days  of  grace  for  payment  and  must  be 
paid  on  presentation,  or  protested.  As  a  rule  the  sale 
of  demand  exchange  is  contined  principally  to  banks, 
commercial  drafts  being  usually  drawn  on  time. 

The  rate  or  price  of  demand  or  sight  exchange,  un- 
der modern  conditions,  may  be  considered  as  the  basic 
rate  on  which  all  rates  for  time  exchange  are  calcu- 
lated. The  old  usance  or  sixty-day  rate,  obtaining 
between  London  and  New  York,  on  which  rates  used 
to  be  calculated  is  a  relic  of  the  days  of  slow-going 
sailing  vessels.  In  practice,  of  course,  given  the  rate 
of  interest,  the  rates  of  exchange  are  quickly  con- 
verted from  one  to  the  other.  Under  normal  condi- 
tions, a  sight  draft  drawn  in  New  York  or  London 
will  be  presented  and  paid  six  to  eight  days  after  nego- 
tiation in  New  York,  and  is  therefore,  as  regards  time 
lost  in  transit,  on  a  par  with  a  shipment  of  gold. 
The  difference  between  the  export  gold  point  and  the 
demand  rate  is  represented  by  the  freight,  insurance* 
charges,  etc.,  on  the  shipment  of  gold.  It  is,  of  course, 
necessary  for  banks  transacting  a  regular  foreign  ex- 


BILLS  OF  EXCHANGE 


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XVIII-IO 


130  INTERNATIONAL  EXCHANGE 

change  business  to  maintain  balances  with  the  various 
foreign  correspondents  against  which  they  can  draw 
demand  drafts  and  sell  cable  transfers.  Funds  for 
these  balances  are  provided  by  remitting  quantities  of 
different  kinds  of  exchange  which  have  been  purchased 
from  customers  and  others.  Demand  and  other  short 
date  items  are  credited  immediately ;  acceptance  is  ob- 
tained of  the  longer  date  items  which  are  discounted 
and  credited  by  the  correspondent  as  occasion  requires. 
The  selhng  of  demand  exchange  and  cables  against 
remittances  of  the  same  is  the  most  elementary  form 
of  foreign  exchange.  A  banker,  for  instance,  pur- 
chases a  demand  draft  on  London  for  £10,000  at  the 
normal  rate  of  exchange,  say  $4.86,  and  remits  the 
bill  to  his  London  correspondent;  at  the  same  time  he 
sells  his  own  check  or  checks  on  London  for  the  same 
amount  at,  say,  $4.86/2;  the  two  transactions  reach 
London  by  the  same  mail  and  offset  each  other. 
Apart  from  the  expense  of  conducting  his  business, 
he  clears  $.50  on  the  transaction  and  is  not  out  of  the 
use  of  his  money  for  more  than  a  few  hours  at  the 
most.  If  the  checks  sold  by  the  banker  miss  the 
mails  by  any  chance,  the  banker  has  the  use  of  the 
money  in  London  until  the  mail  is  received ;  hence  the 
importance  of  watching  the  mail  service  closely  in 
exchange  transactions.  This  illustration  is,  of  course, 
elementary  and  bankers  do  not  often  make  money 
this  way;  but  it  shows  the  principle  on  which  foreign 
exchange  transactions  are  based.  Banks  are  con- 
stantly purchasing  every  kind  of  exchange  and  for- 


BILLS  OF  EXCHANGE 


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132  INTERNATIONAL  EXCHANGE 

warding  it  to  their  foreign  correspondents  by  whom 
it  is  converted  into  an  available  balance.  In  any  case 
there  is  constantly  accumulating  to  the  credit  of  the 
Xew  York  banker  a  balance  against  which  he  is  able 
to  sell  exchange  and  cables  and  meet  his  maturing 
obligations.  Under  normal  conditions,  owing  to  the 
reliability  of  the  mail  service,  a  banker  is  able  to  esti- 
mate very  closely  the  position  of  his  London  balance 
and  as  a  rule  receives  a  cable  from  his  correspond- 
ent at  the  end  of  each  day. 

3.  Cable  transfers, — A  cable  transfer  or  "cable,'*  as 
it  is  more  generally  called,  is  a  transfer  of  funds  by 
cable,  no  question  of  interest  being  involved  as  pay- 
ment is  immediate.  Apart  from  this  a  "cable"  differs 
from  a  check  only  in  the  fact  that  the  banker  abroad 
is  told  by  a  cable,  instead  of  by  a  written  order  or 
check  sent  by  mail,  to  pay  out  the  money.  The  cable 
dispatches  should  be  sent  the  night  before,  or  early 
on  the  morning  of  the  day  on  which  payment  is  due ; 
otherwise,  owing  to  the  difference  of  time  between 
Xew  York  and  London,  the  London  bank  will  be 
closed  and  the  payment  delayed  until  the  following 
day.  As  the  money  is  received  and  paid  on  the  same 
day,  it  is  obvious  that  the  banker  must  charge  a  higher 
rate  of  exchange  for  a  cable  than  he  would  for  a  check, 
because  he  has  the  use  of  the  amount  of  the  latter 
while  it  is  in  transit.  The  mail  time  between  the  two 
points  involved  and  the  current  interest  rate  at  the 
paying  point  are  the  main  factors  which  determine  the 
difference  in  the  rate  of  exchange  between  cables  and 


BILLS   OF  EXCHANGE  133 

demand  drafts.  The  higher  the  rate  of  interest  and 
the  slower  the  mail  steamer,  the  more  the  quotations 
diverge.  With  a  demand  rate  of  exchange  at  $4.86, 
an  eight-day  steamer  and  a  London  market  rate  at 
4%  per  cent,  the  cable  equivalent  would  be  4.8652, 
4. 86+. 0052  (8  days'  interest).  These  rates  are  ren- 
dered more  or  less  divergent  according  to  the  supply 
of  or  demand  for  checks  and  cables  respectively. 

4.  Unusual  rates  for  cables, — It  has  already  been 
noted  that  the  outbreak  of  the  European  war  raised 
cable  rates  on  London  to  an  unprecedented  point. 
In  his  work  on  "International  Exchange"  Mr.  A.  W. 
Margraff  summarizes  the  ordinary  business  conditions 
which  produce  abnormal  rates  as  follow^s: 

1.  Flurries  on  the  New  York  Stock  Exchange  with  the 
incidental  abnormal  high  rates  for  money,  frequently  in- 
duce New  York  bankers  to  sell  their  checks  on  London  for 
amounts  largely  in  excess  of  their  cash  credit  balances  in 
the  hands  of  their  London  bankers,  and  enable  them  to 
relieve  the  stringency  of  the  money  market  and  at  the 
same  time  obtain  a  higher  rate  of  interest  by  loaning  the 
money  realized  in  selling  their  London  checks. 

The  manner  of  covering  those  checks  prior  to  their  pres- 
entation for  payment  in  London  is  and  can  be  effected  only 
thru  the  purchase  of  cable  transfers,  and  these  operations 
when  indulged  in  extensively,  naturally  create  a  brisk 
market  demand  for  cable  transfers,  and  fancy  prices  in 
many  instances  have  to  be  paid. 

2.  Exceptionally  high  rates  for  London  checks,  caused 
by  an  unexpectedly  heavy  inquiry  and  a  scant  supply  of 
commercial  bills  of  exchange,  might  tempt  the  aggressive 
banker  to  avail  himself  of  the  high  price  by  selling  his 
checks  on  London  short,  basing  his  calculations  on  a  de- 
cline in  the  price  of  exchange,  during  the  transit  of  his 


134  INTERNATIONAL  EXCHANGE 

checks  to  a  point  where  he  can  buy  cable  transfers  in  re- 
imbursement for  approximately  the  same  rate  he  sold  his 
checks,  and  in  that  event  he  would  have  had  the  free  use 
of  the  proceeds  of  his  sale  of  checks  in  the  interim  for 
loaning  purposes. 

Unforeseen  circumstances  often  offset  the  calculations  of 
the  financier,  and  instead  of  the  anticipated  decline,  the 
market  has  remained  stationary  or  in  fact  had  an  advance 
and  in  the  face  of  these  conditions  the  many  short  sales 
of  checks  must  still  be  covered  by  cable  transfers  at  about 
any  price  the  seller  may  dictate. 

3.  The  fortnightly  settlement  days  on  the  London  Stock 
Exchange  occurring  about  the  middle  and  the  end  of  each 
month  influence  also  the  price  for  cable  transfers ,  and  New 
York  banking  firms  engaged  in  transactions  in  the  London 
market  frequently  are  called  upon ,  especially  in  a  wide  and 
fluctuating  market,  to  protect  their  operations  by  the  cash 
payment  on  these  days ,  of  very  large  sums  of  money  that 
are  transferred  by  telegraph  and  result  in  a  heavy  demand 
for  cable  transfers. 

4.  There  are  many  bankers  not  averse  to  having  their 
foreign  accounts  show  a  debit  balance  at  various  times 
thruout  the  half-yearly  account  periods,  and  who  thru  a 
sentiment  of  pride  and  an  implied  request  on  the  part  of 
their  European  friends,  always  close  their  accounts  on 
30th  June  and  31st  December  with  a  liberal  cash  credit 
balance  created  in  most  cases  at  the  last  moment  by  the 
purchase  of  cable  transfers. 

The  demand  for  cable  transfers  thru  this  source  is  suflfi- 
ciently  large  to  induce  some  bankers  to  establish  large 
credit  balances  with  their  London  friends  during  the 
months  of  June  and  December,  thereby  placing  themselves 
in  a  position  to  sell  cable  transfers  on  29th  June  and  30th 
December  at  the  advanced  prices  which  usually  obtained 
then . 

5.  Long  eocchange, — Long-time  drafts  may  be 
divided  into  bankers'  long  bills  and  commercial  long 


BILLS  OF  EXCHANGE  135 

bills;  both  classes  are  drawn  at  sixty  or  ninety  days 
after  sight,  except  in  special  cases,  when  the  time  limit 
may  be  longer. 

Commercial  long  bills  with  or  without  documents 
attached  are  drawn  on  foreign  debtors  by  merchants 
and  exporters  against  shipments  of  goods  abroad; 
they  are  usually  purchased  by  bankers  who  remit 
them  to  their  foreign  correspondents  for  collection 
and  credit  and  sell  their  own  bills  against  the  balance 
so  created. 

When  a  bill  of  exchange  is  drawn  for  the  exact 
value  of  the  goods  exported  and  has  the  bill  of  lading 
insurance  certificates,  etc.,  attached,  it  is  known  as  a 
"documentary"  bill  of  exchange.  If  no  documents 
are  attached  to  a  bill,  it  is  known  as  a  "clean"  bill  of 
exchange.  Bankers'  bills  are  invariably  clean  bills, 
while  commercial  bills,  unless  drawn  by  a  house  of 
high  standing  on  another  of  equal  rating,  are  usually 
documentaiy. 

Bills  of  exchange  and  the  accompanying  docu- 
ments are  usually  drawn  in  duplicate.  The  originals 
are  forwarded  on,  the  first  outgoing  steamer,  the 
duplicates  are  sent  by  the  next  mail.  Sometimes  the 
second  bill  of  exchange  is  retained  until  a  satisfactory^ 
sale  can  be  made,  in  which  case  the  maturity  of  the 
bill  is  based  on  the  date  that  the  first  of  exchange  was 
accepted  in  London,  accurately  determined  by  the  ar- 
rival of  the  mail  boat.  The  second  bill  of  exchange 
bears  the  name  and  address  of  the  holder  of  the  ac- 
cepted bill.     Before  payment  the   duplicate   is  at- 


136  INTERNATIONAL  EXCHANGE 

tached  to  the  original.  A  bill  of  exchange  may  be 
taken  up  any  number  of  times  before  it  is  due  and 
be  put  into  circulation  between  each  payment,  but 
once  it  is  paid  by  the  acceptor  on  its  becoming  due  it 
cannot  again  be  put  into  circulation. 

6.  Influence  of  the  interest  rate. — A  bill  drawn, 
say,  on  London  at  sixty  days  after  sight  is  obviously 
not  worth  as  much  to  the  purchaser  as  a  demand  bill. 
He  has  to  pay  for  a  sixty-day  bill  on  delivery,  send 
it  over  to  London,  obtain  acceptance,  and  wait  sixty- 
three  days  after  acceptance  before  the  bill  matures 
and  is  paid;  in  other  words,  there  is  sixty-three  days 
difference  between  the  currencies  of  a  demand  and  a 
sixty-day  bill.  Should  the  purchaser  find  it  incon- 
venient to  await  the  maturity  of  the  bill,  he  can  in- 
struct his  correspondent  in  London  to  discount  it  at 
the  current  rate,  and  have  the  proceeds  placed  to  his 
credit.  In  all  exchange  calculations,  therefore,  the 
rate  of  interest  is  based  on  the  current  rates  obtaining 
in  the  country  on  which  the  bill  is  drawn;  this  rate 
varies  slightly  according  to  the  nature  of  the  bill. 
The  rates  normally  applicable  to  various  classes  of 
bills  are,  roughly,  as  follows: 

Clean  bills  drawn  on  bankers'  private  discount 
rate. 

Clean  bills  drawn  on  first-class  firms — ^%  above 
private  discount  rate. 

Bills,  with  documents  deliverable  on  acceptance — 
%%  below  Bank  of  England  minimum  discount  rate. 

Bills  drawn  at  over  sixty  days  sight,  bear  a  higher 


BILLS   OF  EXCHANGE  137 

rate  of  discount,  as  a  rule,  than  the  market  rate  for 
sixties,  owing  to  the  element  of  risk  on  account  of  the 
possible  change  in  the  discount  rate  during  the  cur- 
rency of  the  bill.  It  is  obvious  that  if  the  London 
rate  of  discount  happens  to  be  higher  than  the  Xew 
York  rate,  the  purchaser  of  a  sixty-day  bill  would 
probably  prefer  to  allow  the  bill  to  run  to  maturity 
rather  than  discount  it  in  London  and  use  the  pro- 
ceeds in  Xew  York.  Conversely,  if  the  London  rate 
was  the  lower  he  would  prefer  to  discount  the  bill  and 
withdraw  the  proceeds  for  use  in  Xew  York.  From 
the  foregoing  it  will  be  seen  that  the  London  rate 
has  a  powerful  influence  on  the  exchange  market. 
The  higher  the  rate  of  discount  the  greater  the  di- 
vergence between  the  rate  of  exchange  on  long  and 
short  bills  on  London.  A  change  in  the  interest  rates 
of  either  London  or  XeA^  York  is  immediately  re- 
flected in  the  price  of  any  bill.  The  conversion  of  a 
demand  rate  to  a  sixty-day  rate  includes  an  allowance 
for  interest  and  British  revenue  stamps  (1  shilling 
per  £100).  With  a  demand  rate  of  4.87  and  a  pri- 
vate discount  rate  in  London  of  3^  per  cent,  a 
banker's  clean  bill  is  worth  4.8385  as  the  following 
calculation  shows : 

New  York  demand  rate  on  London        $487.        per  £100 
less  63  davs'  interest  at3>^%.  .2.93 
Stamp  duty  V20% 24       3.17 


$483.83 
or  the  nearest  commercial  rate,  $4.8385  per  pound 


138  INTERNATIONAL  EXCHANGE 

sterling.  Elsewhere  it  has  been  shown  that  exchange 
rates  between  two  countries  either  correspond  or  tend 
to  correspond;  this  applies,  however,  only  to  the  de- 
mand rates. 

7.  Commercial  long  hills. — Commercial  long  bills 
are  drafts  drawn  at  thirty  days  or  over  by  exporters 
on  foreign  customers,  or  upon  banks  abroad  desig- 
nated by  the  latter.  A  bill  of  this  kind  is  usually  ac- 
companied by  a  bill  of  lading  and  other  documents. 
Where  a  draft  is  drawn  on  a  very  good  house  abroad, 
or  a  bank,  the  documents  are  delivered  upon  the  ac- 
ceptance of  the  draft.  Such  drafts  are  known  as 
''acceptance  bills"  or  D/A. 

Where  the  drawee's  standing  is  less  well-known  or 
where  the  merchandise  is  perishable,  documents  are 
delivered  only  on  actual  payment  of  the  drafts. 
These  drafts  are  known  as  "payment  bills"  or  D/P. 
In  the  case  of  a  draft  marked  D/A,  the  drawee 
can  obtain  possession  of  the  relative  goods  as  soon 
as  he,  or  the  bank  representing  him,  has  accepted 
the  draft.  If  the  draft  be  marked  D/P,  the  drawee 
must  pay  the  draft  (less  a  rebate  for  any  unex- 
pired time  it  has  to  run  to  maturity)  before  he  can 
obtain  the  merchandise.  When  D/P  bills  are  drawn 
against  perishable  goods  they  are  invariably  taken 
up  "under  rebate."  Payment  bills  are  not  discount- 
able, even  after  acceptance,  as  they  are  liable  to  be 
paid  any  time  before  maturity  and  must,  therefore, 
remain  in  the  portfoho  of  the  banker  who  presented 
them  for  acceptance.     "Acceptance  bills,"   on  the 


BILLS  OF  EXCHANGE  IBS' 

other  hand,  become  clean  bills  after  acceptance.  They 
are  discountable  in  the  London  discount  market  and 
may  change  half  a  dozen  times  before  maturity. 

The  purchase  of  documentary  bills  drawn  by  re- 
liable firms  is  a  fairly  safe  operation,  the  buyer  being 
protected  by  the  bill  of  lading  which  is  indorsed  to 
him,  but  judgment  should  be  exercised  as  regards  the 
financial  standing  of  the  drawer  and  drawee,  es- 
pecially in  the  case  of  ''acceptance  bills,"  and  consid- 
eration should  be  given  to  the  nature  of  the  relative 
goods. 

8.  Bankers'  long  bills. — Drafts  drawn  at  sixty 
and  ninety  days  sight,  on  foreign  correspondents  by 
bankers  in  the  United  States  and  Canada,  form  an 
important  factor  in  international  exchange  opera- 
tions. These  bills  originate  in  the  regular  course  of  a 
foreign  exchange  business  and  are  based  on  a  variety 
of  transactions.  Many  of  them  are  thirty  and  sixty- 
day  bills  and  are  sold  to  customers  of  the  bank,  who 
prefer  this  method  of  remittance  to  that  of  purchas- 
ing demand  drafts  or  cable  transfers.  Some  arise 
from  a  desire  to  anticipate  a  change  in  the  rate  of 
exchange,  while  others  represent  purely  financial 
transactions,  such  as  placing  a  foreign  loan  in  Xew 
York.  These  latter  operations  are  explained  in  the 
rhapter  on  Finance  Bills. 

9.  Bills  of  exchange  that  involve  more  or  less  risk. 
• — Concerning  the  risk  incurred  in  the  purchase  of 
documentary  exchange,  A.  W.  Margraff  in  his  book 
'^International  Exchange"  writes  as  follows; 


140  INTERNATIONAL  EXCHANGE 

Bills  of  exchange  that  may  be  purchased  safely. — Bills  ac- 
companied by  documents  covering  staple,  non-perishable 
merchandise  can  be  readily  resold  in  the  market  where  con- 
signed in  the  event  of  forced  sale  by  reason  of  non-accept- 
ance or  non-payment  by  the  drawees  of  the  appertaining 
bill,  and  the  inability  of  drawers  to  reimburse  the  purchaser 
of  the  bill  upon  demand  for  the  amount  originally  paid 
them,  plus  expenses. 

The  proceeds  realized  upon  merchandise  disposed  of 
under  forced  sale  would  be  applied  on  account  of  the 
amount  of  reimbursement  demanded  of  drawers,  and  pro- 
vided the  merchandise  was  of  the  nature  just  referred  to, 
would  almost  liquidate  the  purchaser's  claim  against  the 
drawers,  and  the  small  balance  still  due  to  the  purchaser 
may  be  recovered  with  little  difficulty  from  the  drawers. 
If,  however,  they  have  failed  in  the  meantime,  then  the 
purchaser  would  have  a  creditor's  claim  for  such  balance 
against  the  insolvent  dravv^ers. 

The  possibility  of  such  a  loss  is  very  remote  in  view  of 
the  fact  that  the  majority  of  drawers  of  bills  of  exchange 
(exporters)  have  all  refused  bills  immediately  referred  to 
their  own  agents  abroad  for  protection. 

Staple  and  non-perishable  merchandise  includes  flour 
and  other  manufactured  cereals  such  as  corn  meal,  oat 
meal,  hominy,  etc.;  farming  implements,  canned  meats, 
fresh  meats  and  other  provisions,  when  the  fresh  meats  and 
provisions  are  shipped  in  refrigerator  cars  and  vessels  of 
modern  type,  and  warehoused  in  cold-storage  plants  upon 
the  arrival  at  destination,  if  not  immediately  taken  up  by 
drawees. 

Bills  involving  more  or  less  risk. — Bills  accompanied  by 
documents  representing  shipments  of  perishable  merchan- 
dise, such  as  butter,  cheese,  fresh  fruits,  etc.,  that  are 
liable  to  deterioration  in  quality,  or  to  absolute  loss,  dur- 
ing transit. 

Bills  with  documents  showing  collateral  security  of  live 
cattle,  horses  or  other  live  animals,  necessitating  the  ex- 
pense of  help  and  feed  during  transit  for  the  maintenance 


BILLS   OF  EXCHANGE  141 

of  life,  as  a  refusal  of  such  annexed  bill  would  depreciate 
the  value  of  the  security,  day  by  day,  to  the  extent  of 
such  expense  incurred. 

In  addition  to  the  liability  of  drawers  and  indorsers,  if 
any,  purchasers  of  documentary  bills  are  secured  by  the 
financial  responsibility  of  the  acceptors  on  and  after  ac- 
ceptance until  actual  payment  of  the  bills. 

The  liability  of  drawers  continues  after  the  acceptance  of 
bills,  remains  in  force  during  the  whole  life  of  the  bills  and 
ceases  only  upon  payment. 

The  primary  conditions  of  the  desirability  of  the  pur- 
chase of  any  bill  of  exchange  depend  upon  the  moral  and 
financial  standing  of  the  parties  thereto,  and  the  liabilities 
just  stated  of  the  parties  should  be  quite  ample  in  the  ma- 
jority of  cases.  Further,  these  bills  possess  another  ele- 
ment of  protection  against  a  possible  loss  in  this ,  that  they 
are  supplemented  by  documents  covering  salable  mer- 
chandise with  title  continuing  in  the  purchaser  of  the  bills 
imtil  payment  at  maturity,  or  retirement  prior  to  matur- 
ity, of  the  respective  bills  of  exchange. 

APPLICATION  FOR  COMMERCIAL  CREDIT 


New  York. 


GuARAKTY  Trust  Company  of  New  York. 
Dear  Sirs. 

Please  issue  for  our  account  a  Documentary 
Credit  in  favor  of 


for  £ drafts  at . 

against cost  of  shipment  of. 

from to 

In  force  until  first  day  of 

Insurance  effected  in 

Kindly  advise  the  Credit  by 

Cable 

Mail 

Yours  truly, 

FiGuaE    3. 


U2  IXTERXATIOXAL  EXCHANGE 

Credit  Xo o 

£ Sterling 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK 

New  York, 19. . 

To  the  Guaranty  Trust  Company  of  New  York, 
33  Lombard  Street, 
London. 

Gentlemen: 

A  t  the  request  and  for  account  of 

we   hereby    authorize 

or  an;i  parties  whose  drafts  you  may  he  directed  by. . .  .writteii  order,  or 

by  us,  to  accept  under  this  credit,  to  value  on  you  at for  any 

sum  or  sums  not  exceeding  in  all 

Pounds  Sterling  (say  £ Sterling)  to  be  used  as may 

direct  for invoice  cost  of 

to  be  purchased  for  account  of 

and  to  be  shipped  to  a port  in  the  United  States 

The  Bills  must  be  drawn  in 

prior  to  the  first  day  of 

and  advice  thereof  giren  to  you  in  original  and  duplicate,  such  advice  to 
he  accompanied  by  Bill  of  Lading  filled  up  to  order  of  the  Guaranty 
Trust  Company  of  New  York  (with  copy  of  invoice)  for  the  property 
shipped  as  above. 

All  the  Bills  of  Lading  issued,  except  one  sent  to  us  by  the  vessel 
camiinq  the  cargo,  and  one  retained  by  the  captain  of  the  said  VPttsel,  are 
to  be  for-iii'nrdcd  direct  to  you.  Copy  of  invoice,  properly  certified  by  the 
U.  S.  Consul  to  be  forwarded  to  us  by  the  vessel,  also  advice  of  each  Bill 
drawn. 

And  we  hereby  agree  with  the  drawers,    indorsers,  and   bona  fide 
holders  of  Bills  drawn  under  and  in  compliance  with  this  credit,  that  the 
same  shall  be  duly  honored  on  presentation  at  your  office  in  London. 
We  are.  Gentlemen, 

Your  obedient  servants. 
Guaranty  Trust  Company  of  New  York, 
by 


Manager. 


N.B.  Bills  drawn  under  this  credit  must  he  marked  Drawn 
under  Guaranty  Trust  Company  of  New  York 

Letter  of  Credit  No dated 

for  £ 

Insurance  in  order  at 

Figure  4 . 


BILLS  OF  EXCHANGE  143 

New  York, 19 . . . 

To  the 

GUARANTY  TRUST  COMPANY  OF  NEW  YORK 

Gentlemen: 

Having  received  from  you  the  Letter  of  Credit  of  which  a  true  copy  is 

on  the  other  side,  hereby  agree  to  its  terms,  and  in  consideration 

thereof         agree  with  you  to  provide  in  New  York,  twelve  days  previous 

to  the  Maturity  of  the  Bills  drawn  in  virtue  thereof,  sufficient  funds  in 
cash,  or  in  Bills  on  London,  satisfactory  to  you,  at  not  exceeding  sixty 

days'  sight,  and  indorsed  by  ,  to  meet  the  payment  of  the  same  with 
per  cent  commission  and  interest  as  hereinafter  pro- 
vided,   and          undertake    to   insure    at      ^  expense,    for   your    benefit, 

against  ri^k  of  Fire  or  Sea,  all  property  purchased  or  shipped  pursuant 
to  said  Letter  of  Credit,  in  Companies  satisfactory  to  you. 

agree   that   the   title   to   all  property   which  shall   be   purchased   or 

shipped  under  the  said  credit,  the  bills  of  lading  thereof,  the  policies 
of  insurance  thereon  and  the  whole  of  the  proceeds  thereof,  shall  be  and 
remain  in  you  until  the  payment  of  the  bills  referred  to  and  of  all  sums 
that  may  be  due  or  that  become  due  on  said  bills  or  otherwise,  and 
until  the  payment  of  any  and  all  other  indebtedness  and  liability  now 

existing  or  now  or  hereafter  created  or  incurred  by  "*^    to  you  on  any 

and  all  other  transactions  noio  or  hereafter  had  with  you,  with  authority 
to  take  possession  of  the  same  and  to  dispose  thereof  at  your  discretion 
for  your  reimbursement  as  aforesaid,  at  public  or  private  sale,  without 
demand  or  notice,  and  to  charge  all  expenses,  including  commission  for 
sale  and  guarantee. 

Should  the  market  value  of  said  merchandise  in  New  York,  either  be- 
fore or  after  its  arrival,  fall  so  that  the  net  proceeds  thereof  (all  ex- 
penses, freight,   duties,   etc.,   being   deducted)    would   be   insufficient   to 

cover  your  advances  there  against  with  commission  and  interest,  fur- 
ther agree  to  give  you  on  demand  any  further  security  you  may  require, 
and  in  default  thereof  yon  shall  he  entitled  to  sell  said  merchandise  forth- 
with, or  to  sell  "to  arrive,"  irrespective  of  the  maturity  of  the  accept- 
ances under  this  Credit,         being  held  responsible  to  you  for  any  deficit, 

which  ,       bind  and  oblige  J^l'^^iJ,       to  pay  you  in  cash  on  demand. 

It  is  understood  that  in  all  payments  made  by  ^^  to  you  in  the  United 

States,  the  Pound  Sterling  shall  he  mlnilnted  at  the  current  rate  of 
exchange  for  Bankers  Bills  in  New   York   on  London,   existing  at   the 

Figure    5. 


X44  INTERNATIONAL  EXCHANGE 

time  of  settlement,  and  that  interest  shall  be  charged  at  the  rate  of  five 
per  cent  per  annum,  or  at  the  current  Bank  of  England  rate  in  London 
if  above  five  per  cent. 

Should  .  anticipate  the  pat/ment  of  any  portion  of  the  amount  pay- 
able, interest  is  to  be  allowed  at  a  rate  of  one  per  cent  under  the  cur- 
rent Bank  of  England  rate. 

In  case  .  should  hereafter  desire  to  have  this  credit  confirmed,  al- 
tered or  extended  by  cable  (which  will  be  at    "'^^{expense  and  risk), 

hereby  agree  to  hold  you  harmless  and  free  from  responsibility  from 
errors  in  cabling,  whether  on  the  part  of  yourselves  or  your  Agents^ 
here  or  elsewhere,  or  on  the  part  of  the  cable  companies. 

This  obligation  is  to  continue  in  force,  and  to  be  applicable  to  all 
transactions ,  notwithstanding  any  change  in  the  composition  of  the  firm 
or  firms,  parties  to  this  contract  or  in  the  user  of  this  credit,  whether 
such  change  shall  arise  from  the  accession  of  one  or  more  new  partners, 
or  from  the  death  or  secession  of  any  partner  or  partners. 

It  is  understood  and  agreed  that  if  the  documents  representing  the 
property  for  which  the  said  Credit  has  been  issued  are  surrendered  under 
a  trust  receipt,  collateral  security  satisfactory  to  the  Company,  such  as 
stocks,  bonds,  warehouse  receipts  or  other  security,  shall  be  given  to  the 
Company,  to  be  held  unlil  the  terms  of  the  credit  have  been  fully  satis- 
fied, and  subject  in  every  respect  to  the  conditions  of  this  agreement. 

It  is  further  understood  and  agreed  in  the  event  of  any  suspension, 

or  failure,  or  assignment  for  the  benefit  of  creditors  on  ^^  part,  or  of 

the  nonpayment  at  maturity  of  any  acceptance  made  by  ,  or  of  the 
nonfulfilment  of  any  obligation  under  said  credit  or  under  any  other 
credit   issued  by   the   Guaranty   Trust   Company   of  New   York  on       \, 

account,  or  of  any  indebtedness  or  liability  on  "^^  part  to  you,  all  obli- 
gations, acceptances,  indebtedness  and  liabilities  whatsoever  shall  there- 
upon, at  your  option  then  or  thereafter  exercised,  without  notice,  mature 
and  become  due  and  payable. 

Figure  15.     (Continuation) 

10.  Letters  of  credit. — There  are  two  well-known 
forms  of  letters  of  credit : 

1.  Circular  letters  of  credit,  to  be  used  by  travelers  and 
tourists.  These  are  addressed  to  the  foreign  correspondent 
of  the  issuing  bank  in  favor  of  the  holder. 

2.  Commercial  letters  of  credit,  to  be  used  in  trade. 
These  take  the  form  of  a  letter  addressed  by  a  bank  to  a 


BILLS  OF  EXCHANGE  145 

foreign  merchant .  authorizing  him  to  draw  on  the  issuing 
bank's  correspondent  in  a  certain  place  (generally  a  finan- 
cial center  such  as  London  or  New  York)  for  a  specified 
amount  representing  the  cost  price  of  certain  goods  or- 
dered by  the  bank's  customer,  on  whose  behalf  the  credit 
is  issued.  The  letter  designates  a  time-limit  and  specifies 
that  all  drafts  shall  be  accompanied  by  the  relative  in- 
voice, bill  of  lading,  insurance  policy,  consular  certificate, 
etc. 

Before  issuing  a  commercial  letter  of  credit  the 
bank  requires  the  customer  to  sign  an  application 
form  (Fig.  3  on  page  141)  setting  forth  the  par- 
ticulars and  terms  of  the  shipment  and  giving  instruc- 
tion in  regard  to  terms,  insurance,  etc.,  all  of  which 
are  embodied  in  the  letter  of  credit,  wdiich  is  issued  by 
the  bank  in  four  parts,  namely,  one  original  and  three 
copies  (these  copies  however  vary  but  slightly  from 
the  original). 

1 .  The  original  is  addressed  to  the  foreign  merchants  in 
whose  favor  the  credit  is  issued.  This  is  handed  to  the 
customer,  who  forwards  it  to  his  correspondent. 

2.  A  copy  is  addressed  to  the  London  or  New  York  bank 
on  which  the  credit  is  issued,  authorizing  it  to  protect  the 
drafts  against  the  credit  when  drawn  in  accordance  with 
the  terms  and  conditions  thereof. 

3.  A  copy  of  the  original  is  delivered  to  the  customer 
for  his  files. 

4.  A  copy  is  retained  by  the  bank  issuing  the  credit. 

On  the  reverse  side  of  the  last  two  copies  is  a  receipt, 
signed  by  the  customer,  incorporating  an  agreement 
regarding  the  basis  on  wdiich  the  bank  is  to  be  re- 
imbursed, and  the  amount  of  its  commission  (which 
varies  according  to  the  currency  of  the  bill  drawn). 

XVIII— 11. 


146  INTERNATIONAL  EXCHANGE 

The  bank's  rights  in  case  of  default  in  payment  or 
other  difficulties  are  also  defined  (Fig.    5). 

Commercial  letters  of  credit  are  invaluable  factors, 
and  in  the  promotion  of  international  trade  and  com- 
merce greatly  facilitate  the  negotiation  of  bills  of  ex- 
change, not  only  in  the  import  business  of  a  country 
but  also  in  the  export  business.  Letters  of  credit,  tho 
not  themselves  negotiable,  render  valuable  service  to 
commerce  by  facilitating  the  drawing  and  negotiation 
of  bills  of  exchange  thruout  the  world. 

REVIEW 

What  are  the  two  classes  of  bills  of  exchange  and  what  does 
each  include? 

How  does  a  cable  transfer  differ  from  a  check?  Why  are 
higher  rates  of  exchange  charged  for  it  than  for  a  check?  What 
are  the  main  factors  which  determine  the  difference  in  exchange 
rates  between  cable  transfers  and  demand  drafts? 

What  conditions  will  tend  to  produce   abnormal  cable  rates? 

What  are:  (a)  commercial  long  bills;  (b)  documentary  bills  of 
exchange;  (c)  clean  bills  of  exchange?  Give  an  illustration  of  a 
clean  bill  and  of  a  documentary  bill. 

Describe  the  kind  of  bills  of  exchange  which  are  considered 
safe  to  buy  and  those  which  involve  risk.  \^Tiat  are  the  primary 
conditions  which  make  the  purchase  of  a  bill  of  exchange  desira- 
ble? 


CHAPTER  X 

FOREIGN  REMITTANCES 

1.  Non-commercial  exchange, — Altho  the  greater 
portion  of  foreign  exchange  originates  in  commercial 
transactions,  there  is  a  constantly  increasing  volume 
of  exchange  business  created  by  travelers  and  immi- 
gration. A  steady  stream  of  travelers  and  others 
leave  the  United  States  and  Canada  each  year  to  visit 
Great  Britain,  Europe  and  other  parts  of  the  world, 
carrying  with  them  the  necessary  funds  for  their  ex- 
penses in  various  forms,  such  as  circular  letters  of 
credit,  travelers'  checks,  drafts  and  gold. 

The  remittances  of  immigrants  to  their  relatives 
and  friends  in  their  home  lands  amount  to  a  surpris- 
ingly large  figure  in  the  course  of  a  year.  These  re- 
mittances are  generally  made  by  means  of  drafts, 
foreign  money  orders,  or  by  what  are  called  mail  re- 
mittances. 

For  many  years  these  two  classes  of  foreign  busi- 
ness were  in  the  hands  of  foreign  bankers  who  mado 
a  specialty  of  the  business  of  supplying  banks,  both 
in  the  United  States  and  Canada,  with  the  necessary 
forms  and  foreign  machinery  for  issuing  circular  let^ 
ters  of  credit  and  selling  travelers'  checks.  Gradu^ 
ally  the  larger  banks  both  in  the  United  States  and 

147 


148  INTERNATIONAL  EXCHANGE 

Canada  felt  the  increasing  pressure  of  their  clients' 
requirements  in  this  connection,  and  found  it  advis- 
able to  establish  their  own  systems  of  travelers' 
checks,  etc.  Practically  every  important  bank  has 
now  direct  correspondents  in  the  principal  cities  of 
the  world  with  W'hom  they  have  made  the  necessary 
arrangements  for  the  payment  of  circular  letters, 
travelers'  checks  and  the  like. 

A  comparison  of  the  different  methods  of  remit- 
tance and  a  description  of  the  manner  in  which  they 
are  operated  is  interesting. 

2.  Principles  underlying  the  issuance  of  drafts. — 
A  demand  draft  or  check  is  an  unconditional  order 
issued  by  one  bank  on  another  bank  or  banking  firm 
asking  the  bank  to  whom  it  is  addressed  to  pay  a  cer- 
tain sum  of  money  to  a  specified  person  or  institution. 
(See  Figure  6.) 

In  the  case  of  a  bank  keeping  an  account  in  an- 
other country  w^here  the  exchange  value  of  the  cur- 
rency is  steady  and  for  which  rate  quotations  are 
easily  obtainable,  drafts  are  usually  drawn  in  the  cur- 
rency of  that  country  and,  after  payment,  are  charged 
to  the  account  w^hich  the  issuing  bank  keeps  with  its 
correspondent  at  the  face  amount.  If  the  arrange- 
ment calls  for  payment  of  the  drafts  at  par,  the  corre- 
spondent's commission  (if  any)  is  added  to  the  face 
amount  of  the  draft  when  charged  to  the  account. 
Drafts  are  often  made  payable  at  the  office  of  a  third 
bank  or  banking  firm  for  account  of  the  issuing  bank's 
correspondent. 


FOREIGN  REMITTANCES  149 

Drafts  are  also  issued  on  correspondents  with  whom 
no  account  is  kept.  In  such  cases,  cover-drafts  in 
favor  of  the  correspondent  for  the  amounts  invohei 


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(hlicTt«ruirid'(iiiifsoauiuif^lcnrsforll, 


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Figure  6.     Draft 

plus  commission,  drawn  against  the  issuing  hank's  ac- 
count in  one  of  the  large  selling  cities  (London,  Paris, 
Berlin,  Xew  York,  etc.)  are  forwarded  with  the 
relative  letters  of  advice,  or  the  correspondent  is  re- 
quested to   forward  the   paid   draft   to  the   issuing 


150  INTERNATIONAL  EXCHANGE 

bank's  correspondent  in  one  of  these  cities  for  re- 
demption. 

When  a  bank  is  requested  to  issue  drafts  on  a  coun- 
try for  which  it  has  made  no  draft  arrangements,  a 
sterhng  draft  on  its  London  branch  or  correspondent 
was  usually  sold.  Sterling  drafts  on  London  have 
been  more  easily  negotiated  than  those  drawn  in  other 
currencies,  owing  to  the  fact  that  the  great  majority 
of  banks  thruout  the  world  have  correspondents  or  ac- 
counts in  that  city,  and  the  exchange  rates  for  sterling 
were  much  steadier  and  more  widely  quoted  than 
those  for  other  currencies. 

To  guard  against  loss  in  the  case  of  countries  in 
Africa,  Asia  or  South  America  where  silver  units 
exist  or  the  exchange  value  of  the  currency  is  subject 
to  great  fluctuations,  drafts  are  usually  drawn  in 
sterling  on  the  London  branch  or  correspondent  of 
the  issuing  bank  and  crossed  "Payable  at  the  drawees' 
buying  rate  for  sight  bills  on  London,"  or  with  a 
phrase  similar  in  meanhig.  The  correspondent  on 
whom  such  drafts  are  drawn  pays  them  in  local  cur- 
rency at  a  rate  of  exchange  which  includes  his  com- 
mission and  other  charges,  and  afterward  forwards 
them  to  London  for  redemption  at  the  face  amount 
of  sterling. 

3.  Advices. — A  letter  of  advice  (Figure  7),  au- 
thenticating the  draft  and  usually  containing  the  fol- 
lowing particulars,  is  sent  to  the  branch  or  corre- 
spondent on  vvdiom  the  draft  is  drawn: 

1.  Xumber  of  the  draft 


FOREIGN  REMITTANCES 


151 


2.  Amount  of  the  draft 

3.  Date  of  issue  of  draft 

4.  Name  of  payee 

5.  Name  of  bank  at  which  drafts  will  be  presented 
by  bearer  if  other  than  correspondent  drawn  on  (if 


THE  NATIONAL  CITY  BANK 


OF  NEW   YORK 

OEPAHTMKMt 


NEW  YOW^. 


MESSRS.  LONDON  CITY  i  MIOUND  BANK.  LTD, 

LONDON.  E.  C. 
DEAK  SIRS: 

We  b«g  to  advise  having  bsued   the  (ollowio^  drafts  upon  your  goodsMves  whicfc  kindly  protect  t» 
our  debit  m  account  under  advice. 


NyMBtR 

AMOUNT 

ORDER 

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Voun  traly. 

FiGTTRE  7.     Letter  of  Advice   (Drafts) 


152  INTERNATIONAL  EXCHANGE 

the  draft  is  to  be  readvised  to  bank  at  which  it 
will  be  presented,  a  note  to  this  effect  is  added  to 
the  advice) . 

6.  Particulars  of  the  mode  of  reimbursement 
(cover-draft  inclosed,  debit  amount  to  account,  etc.). 

Should  the  draft  be  payable  by  a  third  party  (see 
above)  for  account  of  the  correspondent  on  whom  it 
is  drawn,  this  third  party  is  also  advised  either  by  the 
issuing  bank  direct  or  by  its  correspondent  on  receipt 
of  advice  from  the  issuing  bank. 

The  relative  advices  should  be  dispatched  as  soon 
as  possible  after  the  sale  of  the  drafts  in  order  that 
payment  may  not  be  refused  thru  the  correspondent's 
being  unable  (in  the  absence  of  advice)  to  authenti- 
cate the  drafts. 

4.  Specimen  forms  and  signatures. — Each  bank 
furnishes  tlie  correspondents  on  whom  it  has  arranged 
to  issue  drafts,  with  specimens  of  the  special  draft 
form  and  of  the  special  advice  form  (if  any)  it  will 
use,  together  w^ith  specimen  signatures  of  the  officers 
who  are  authorized  to  sign  drafts  and  advices  on  its 
behalf.  If  possible,  a  specimen  signature  of  the 
payee  is  also  forwarded  with  the  advice  of  a  draft,  so 
that  any  possible  difficulty  in  establishing  the  bona 
fides  of  the  payee  and  draft  may  be  avoided. 

5.  Cost  of  drafts  to  purchasers, — The  amount  to 
be  charged  by  the  issuing  bank  to  the  purchaser  of  a 
demand  draft  is  ascertained  by  adding  together  the 
amounts  mentioned  below : 

1.  Face  amount  of  the  draft   (if  drawn  in  a  for- 


FOREIGN  REMITTANCES  153 

eign  currency  the  amount  is  converted  into  local  cur- 
rency at  the  rate  of  exchange  for  the  day) 

2.  Connnission  of  the  issuing  bank 

3.  Commission  (if  any)  of  the  paying  bank 

4.  Cost  of  postage  on  advices. 

6.  Travelers'  checks. — Travelers'  checks  enable  a 
traveler  to  provide  himself  with  funds  without  delay 
in  a  convenient  yet  inexpensive  manner,  at  any  point 
of  his  iournev.  They  are  issued  in  denominations 
of  even  amounts  ($10,  $20,  $50,  $100  and  $200;  £o, 
£10;  200  francs  and  400  francs.  Equivalents  in  for- 
eign money  are  now  no  longer  stated  upon  such 
checks.  (See  Figures  8  and  9.)  They  may  be 
cashed  practically  anywhere,  are  self -identifying  and 
easily  negotiated,  and  are  therefore  one  of  the  safest 
and  best  forms  in  which  to  carry  money  w^hen  trav- 
eling. They  are  issued  by  all  first-class  banks  at  a 
.small  premium.  • 

So  far  as  travelers  are  concerned,  such  checks  are 
often  more  convenient  than  drafts.  The  latter  nuist 
be  cashed  in  one  lump  sum  which  may  be  much  larger 
than  the  traveler  wishes  tc  carry  on  his  person,  and 
which  may  be  a  positive  disadvantage  if  he  passes  into 
another  country  where  a  different  currency  is  in  use. 
The  checks  are  for  relatively  small  amoimts,  can  be 
cashed  as  needed  and  are  generally  accepted  by  hotels 
and  large  stores,  without  imposing  on  the  traveler  the 
burden  of  cashing  them  at  a  bank. 

In  view  of  the  undoubted  advantages  in  their  par- 
ticular sphere  which  travelers'   checks  possess  over 

XVIII— 10 


154  INTERNATIONAL  EXCHANGE 

drafts,  their  greater  cost,  the  widespread  nature  of  the 
initial  arrangements  and  the  fact  that  the  exchange 
charged  by  correspondents  on  the  checks  is  met  by  the 
issuing  bank,  the  shghtly  higher  commission  charge 
which  is  made  by  banks  for  travelers'  checks  is  fully 
lustified. 

7.  Payment  of  checks, — The  issuing  bank  usually 
holds  the  paying  agents  of  their  travelers'  checks 
free  from  responsibility  in  cashing  such  checks, 
provided : 

(a)  The  holder  signs  them  in  the  presence  of  the 
paying  agent. 

(b)  The  signature  of  the  holder  and  that  of  the 
countersigning  officer  agree  with  the  signatures  con- 
tained in  the  relative  letter  of  indication. 

(c)  The  numbers  of  the  checks  are  entered  on  the 
letter  of  indication. 

(d)  The  checks  are  negotiated  within  the  period 
specified  (usually  twelve  months  from  date  of  issue). 

(e)  The  other  general  terms  of  the  circular  of  in- 
structions are  duly  comphed  with.^ 

8.  Payment  to  holders. — In  countries  other  than 
France  or  Great  Britain  travelers'  checks  are  now 
23aid  in  local  currency  at  the  day's  rate  for  the  coun- 
try in  whose  currency  they  are  drawn.  When  rev- 
enue stamps  are  required  their  price  is  deducted. 

When  a  fixed  amount  of  sterling  is  specified  for 
Great  Britain  on  the  face  of  travelers'  checks,  it  should 

1  This  circular  of  instructions  is  generally  printed  in  the  principal  com- 
mercial languages  for  the  benefit  of  paying  agents. 


FOREIGN  REMITTANCES 


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INTERNATIONAL  EXCHANGE 


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FOREIGN  REMITTANCES  157 

be  borne  in  mind  that  the  sterling  current  in  Aus- 
traha,  British  South  Africa,  British  West  Indies, 
etc.,  is  of  a  quite  different  exchange  value.  A  sim- 
ilar remark  may  also  be  made  regarding  the  colonies 
and  dependencies  of  other  countries  which  use  the 
same  currency  (francs,  etc.)  as  the  respective  mother 
country.  In  such  places  all  travelers'  checks  are  paid 
at  the  current  rate  for  purchasing  exchange  on  the 
cajiital  of  the  respective  mother  country, 

9.  Redemption  of  checks. — Paid  travelers'  checks 
are  redeemed  as  follows : 

(a)  If  paid  in  Xorth  America,  they  are  forwarded 
to  the  Xew  York  office  or  correspondent  of  the  issu- 
ing bank  of  redemption  at  the  face  amount  of  dollars 
plus  the  commission  agi^eed  upon.^ 

(b)  If  paid  outside  Xorth  America,  they  are  for- 
warded to  the  London,  England,  branch  or  corre- 
spondent of  the  issuing  bank  for  redemption  at  the 
current  rate  of  exchange  plus  commission  at  the  rate 
agreed  upon  or  when  issued  in  dollars  are  returned  to 
New  York  either  directly  or  indirectly  to  be  redeemed 
to  the  credit  of  the  foreign  banker  who  cashed  them. 
A  number  of  purely  temporary  expedients  have  been 
resorted  to  in  view  of  the  unsettled  condition  of  ster- 

1  As  travelers'  checks  paid  in  Xorth  America  are  checks  on  Xew  York, 
banks  at  points  where  Xew  York  exchange  is  usually  at  a  premium  often 
make  no  commission  charge  for  cashing  the  checks. 

In  the  case  of  Canadian  banks  which  issue  travelers'  checks,  it  is  cus- 
tomary to  redeem  each  other's  checks  at  par  when  the  two  banks  con- 
cerned are  represented  locally.  In  other  cases  they  are  redeemed  thru 
the  Clearing  House  or  otherwise  by  any  branch  of  the  issuing  bank  which 
is  convenient  for  the  purpose,  at  the  face  ajnount  plus  the  usual  commis- 
sion on  checks  paid  and  redeemed  in  Xorth  America,  namely,  i  lo  of  1  P^r 
cent,  minimum  5  cents  each. 


158  INTERNATIONAL  EXCHxVNGE 

ling.     It  is  believed  these  will  in  time  give  place  to 
the  former  more  convenient  methods. 

(c)  Banks  having  extensive  business  relations  with 
various  European  countries  occasionally  appoint  their 
chief  correspondents  in  the  respective  countries  as  cen- 
tral redemption  agents  for  their  travelers'  checks. 
In  such  cases  the  paid  checks  are  forwarded  to  these 
correspondents  for  redemption  at  the  face  amount  of 
local  currency  plus  the  commission  agreed  upon,  and 
are  debited  to  the  account  which  the  issuing  banks 
keep  with  these  correspondents. 

(d)  Hotels,  department  stores  and  private  bankers 
often  hand  travelers'  checks  paid  b\^  them  to  a  local 
bank  for  redemption,  such  third  parties  being  allowed 
a  commission  of,  say,  V20  of  1  per  cent,  which  is  added 
by  the  local  bank  to  its  own  commission  when  forward- 
ing the  check  to  a  central  correspondent  for  redemp- 
tion. 

10.  Letter  of  indication, — Each  purchaser  of  trav- 
elers' checks  is  furnished  with  a  letter  of  indication 
( Figure  10) ,  usually  bound  with  the  list  of  paying 
agents,  specifying  the  numbers  of  the  travelers'  checks 
sold  to  him  and  signed  by  the  purchaser  and  the  officer 
who  countersigned  the  checks.  It  is  indispensable  to 
the  security  of  the  holder  that  this  letter  of  indication 
be  carried  separately  from  the  travelers'  checks,  as  in 
case  of  loss  of  one  or  the  other  the  one  remaining 
serves  as  the  basis  of  a  claim  for  reimbursement. 

A  few  institutions  do  not  issue  a  letter  of  indica- 
tion with  their  travelers'  checks.     In  these  cases  two 


FOREIGN  REMITTANCES  159 

spaces,  one  at  the  top  and  one  at  the  bottom  (see 
Figure  11), are  provided  on  the  check  form  for  the  sig- 
nature of  the  holder.  The  first  signature  is  made  in 
the  presence  of  the  officer  who  issues  the  checks,  and 
the  second  in  the  presence  of  the  paying  agent,  who 
compares  the  two  signatures  to  estabhsh  their  identity. 
This  system,  however,  readily  lends  itself  to  forgery 
should  the  checks  be  lost  or  stolen,  as  the  presenter  of 
the  checks  has  a  copy  of  the  necessary  signature  be- 
fore him  while  signing  the  checks,  or  the  signature 
may  be  lightly  traced  in  pencil  in  the  space  provided 
before  jjresentation  and  covered  with  ink  in  the  pres- 
ence of  the  paying  agent. 

During  1913  the  Federation  Universalle  des  Soci- 
etes  d' Hoteliers  (with  which  the  principal  hotels  of 
the  world  are  associated)  addressed  a  circular  letter 
to  the  various  issuers  of  travelers'  checks  stating  that 
in  view  of  the  risk  involved,  j)ayment  by  the  leading 
hotels  of  travelers'  checks  of  this  form  would  there- 
after be  more  or  less  uncertain,  and  suggesting  that 
the  banks  adopt  the  safer  method  whereby  the  speci- 
men signatures  of  the  jiurchaser  and  the  countersign- 
ing officer  are  given  in  a  separate  letter  of  indica- 
tion. 

11.  Lost  travelers'  checks. — The  same  care  should 
be  taken  of  travelers'  checks  as  of  money,  and  due 
precautions  taken  to  avoid  risk  of  loss.  Should  this 
occur,  however,  the  holder  is  advised  to  communicate 
immediately  by  telegraph  with  one  of  the  redemption 
agencies  of  the  issuing  bank  or  the  branch  at  which 


160  INTERNATIONAL  EXCHANGE 

the  checks  were  obtained,  so  that  the  presenter  of 
such  checks  may  be  traced  without  delay. 

The  issuing  bank  will  usually  refund  to  the  owner 
the  face  value  of  lost  or  destroyed  checks,  or  will  issue 
a  new  supply  in  their  stead,  upon  receipt  of  sufficient 
evidence  of  loss  or  destruction  thereof  and  the  execu- 
tion of  a  satisfactory  bond  of  indemnity,  provided  the 
holder  immediately  notifies  the  bank  by  telegraph  of 
the  loss  as  mentioned  above. 

Travelers'  checks  are  useful  for  those  carrying  com- 
paratively small  simis  of  money,  as  they  can  be  nego- 
tiated at  hotels,  department  stores,  etc.,  where  it  is 
impossible  to  secure  funds  under  letters  of  credit,  but 
those  who  require  to  provide  themselves  with  large 
sums,  say,  $1,000  or  over,  will  find  a  letter  of  credit 
more  convenient.  A  good  plan  for  many  travelers 
is  to  carry  both. 

12.  Letters  of  credit. — The  principal  banks  of  the 
world  issue  letters  of  credit  designed  specially  for  the 
use  of  travelers.  They  are  accompanied  by  a  letter  of 
indication  (Figure  12) ,  and  are  of  two  kinds,  namely: 
(a)  Domestic,  drawn  in  local  currency  for  use  in  the 
country  where  they  are  issued  as,  for  example,  dollars 
in  America  and  francs  in  France,  (Figures  13  and 
13A) ,  and,  (b)  Foreign,  now  usually  drawn  in  dollars 
and  similar  in  form  to  Figure  13  tho  letters  in  sterling 
and  francs  are  available  (Figures  14  and  14A). 

The  holder  of  one  of  these  credits  may  draw  any 
sum  he  desires,  up  to  the  amount  of  the  credit,  thru 
correspondents  at  all  the  principal  places  visited  by 


s     ?'5t^i«55: 


;i 


I  ■■a 


xvm-12 


161 


To 

M 
wh 
as 
No. 

.No. 

No. 

No 

No. 

SIG 

Our  Correspoxdi 
Gentlemen, 

19.     . 

:nts  : 

3se  signature  is  to 
follows : 
X 

A 

B    

be  found  below,  is  the  holder  of  "bur  Travel 

to  No.  X 

of  the  denomination  of  $10. 
to  No.   A - 

ers'  Checks 
.inclusive, 
.  inclusive, 

of  the  denomination  of  $20. 
to  No.   B 

c 

of  the  denomination  of  $50. 
to  No.  C 

... 

.  .inclusive, 

inolii.isivft 

D    

of  the  denomination  of  $100. 
to  No    D 

.  We  commend   .  . 

NATURE    or 

of  the  denomination  of  $200. 

to  your  usual 

For  The 

courtesies. 
Bakk 

(This  signature  r 
countersignature 

nust 
on 

agree  with  the 
the   checks.) 

{Must  be  inserted  at  the  time  the  checks 
are  purchased.) 

LETTER  OF  IXDICATIOX  ACCOMPAXYIXG  TRAVELERS' 

CHECKS 
Figure  10 


19- 


To  Our  Correspondents: 
Gentlemen, 

M      

the  bearer  of  this  letter,  who<;e  signature  is  to  be  found  below,  has  been  su])- 

plied  with  our  Circular  Letter  of  Credit  No and  we  commend 

to  your  usual  courtesies. 


For  The Bank 


SIGNATURE  OF 


LETTER  OF  IXDICATIOX  ACCOMPAXYIXG  LETTER  OF 
CREDIT 
Figure  12 

1G2 


FOREIGN  REMITTANCES 


163 


li^Ht^Fyri 


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Figure  13.  Circul.\r  (Dollar)  Letter  of  Credit  (Front) 


164  INTERNATIONAL  EXCHANGE 


"^ 


KUIT    NJt^SI     1J.V.   iKSCKifclBD    OM    J^H  I S    SOA.QS   A.:-.I>   N^I 


rjCJI.I->.K^     TJ     ^^     CUBlfcfc.NCV 


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a 


\l 


Figure  13a.    Circular  (Dollar)  Letter  of  Credit  (Back) 


Xg 


Circular  Letter  of  Credit 

£ Stg. 

ISSUED    BY 

THE BANK. 

19.... 

To  the  Banlers 

named  in  our  Letter  of  Indication. 

This  letter  kHI  be  presented  to  you  b// 

in  whose  favor  ice  haze  opened  a  credit  oi 

o  ,  = Sterliiici 

to  be  availed  of  by demand  drafts  on 

The BanK',  London. 

ichich  we  request  that  you  will  negotiate  at  the  current 
rate  of  the  day,  less  your  usual  charges. 

The  drafts  should  bear  the  following  clause: — 

''Drawn  under  Credit  Xo ";  they  should  be 

drawn  within  one  year  from  the  date  hereof y  and  the 
date  and  amount  of  each  draft  cashed  are  to  be  entered 
in  the  space  provided  on  the  back  of  this  letter. 

M 

provided   with    a    copy    of    our   Letter   of    Indication, 

whereon s'^rpuiture  may  be  found. 

For  The Bank. 


CIRCULAR   (STERLING)   LETTER  OF  CREDIT 
Figure  14 


SPECIFICATION 

Of  Payments  Made  Under  This  Letter 
OF  Credit 


Date 

When 
Paid 


Paid  by 


Amount  in  Words 


Amount 

in 
Figures 


CIRCULAR   (STERLING)   LETTER  OF  CREDIT   (Back) 
Figure  14a 

i:g 


FOREIGN  REMITTANCES  167 

business  men  and  tourists  thruout  the  world.     A  list 
of  paying  agents  is  supplied  to  each  purchaser. 

13.  Payinent  to  the  holder. — The  holder  draws  a 
draft  on  the  central  correspondent  of  the  issuing  bank 
designated  in  the  letter  of  credit  for  the  amount  of 
money  he  requires  and  presents  it  to  one  of  the  pay- 
ing agents  designated  in  the  list  of  payhig  agents. 
The  paying  agent  then  compares  the  signature  on  the 
draft  with  that  given  in  the  relative  letter  of  indica- 
tion and  authenticates  the  signature  of  the  officers 
appearing  on  the  letter  of  credit  by  ineans  of  the  spec- 
imens he  has  on  file.  If  the  signatures  are  in  order 
he  makes  payment  and  enters  the  particulars  of  the 
draft  on  the  back  of  the  letter  of  credit. 

In  accordance  with  the  usual  banking  custom  the 
paying  agent  deducts  his  commission  at  the  time  pay- 
ment is  made  to  the  holder  of  the  letter  of  credit,  but 
should  the  letter  of  credit  request  him  to  make  pay- 
ments without  deduction,  his  commission  is  added  to 
the  amount  of  the  draft  when  forwarding  it  for  re- 
demption to  the  branch  or  correspondent  of  the  issu- 
ing bank  named  in  the  letter  of  credit.  If  the  letter 
of  credit  is  not  drawn  in  local  currency,  the  paying 
agent  makes  payment  at  a  rate  of  exchange  which  in- 
cludes his  commission. 

The  banker  who  pays  the  draft,  exhausting  the  let- 
ter of  credit,  forwards  it  to  the  central  agent  together 
with  the  draft  for  redemption. 

Advised  or  restricted  letters  of  credit  are  similar  in 
form  to  circular  letters  of  credit,  except  that  they  are 


168  IXTERNATIOXAL  EXCHANGE 

advised  direct  to  the  correspondents  to  whom  they  vrill 
be  presented  for  payment,  and  specimen  signatures  of 
the  holder  are  forwarded  to  these  correspondents,  so 
that  a  letter  of  indication  is  unnecessary. 

Letters  of  credit  are  available  for  the  period  speci- 
fied thereon  only  (generalh'  twelve  months  or  less), 
and  paying  agents  should  always  take  care  to  see  that 
this  period  has  not  expired  when  a  letter  of  credit  is 
presented  to  them  for  negotiation. 

14.  Circular  notes. — Circular  notes  (often  written 
in  French)  are  similar  in  form,  payment  and  redemp- 
tion to  travelers'  checks.  They  are  issued  for  fixed 
even  amounts  of  a  given  currency  (pounds  sterling, 
dollars,  etc.),  and  are  payable  at  that  amount  with- 
out deduction  in  countries  which  use  that  currency. 
In  countries  where  the  local  currency  differs  from  that 
designated  on  the  circular  notes,  the  equivalent  of  the 
amount  is  paid  at  the  current  rate  of  exchange.  Al- 
tho  formerly  very  popular,  circular  notes  have  largely 
fallen  into  disuse.  Only  two  British  banks  were  issu- 
ing them  in  Xovember,  1920,  and  the  important  tour- 
ist companies  had  practically  discontinued  selling 
them. 

15.  Foreign  money  orders. — There  is  no  cheaper, 
safer  or  more  convenient  means  of  remitting  small 
sums  of  money  to  any  part  of  the  world  than  that  of 
foreign  money  orders  or  bankers'  limited  checks  ( Fig- 
ure 16).  The  latter  have  fixed  limits  in  various  cur- 
rencies, the  rates  of  exchange  being  determined  at  the 
time  the  notes  are  purchased  in  America. 


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170 


FOREIGN  REMITTANCES  171 

16.  Payment  of  orders. — Foreign  money  orders 
are  not  usually  advised  to  the  paying  agents,  but  the 
issuing  bank,  as  a  rule,  holds  the  paying  agents  of 
their  foreign  money  orders  free  from  responsibility  in 
cashing  them,  provided : 

(a)  The  money  orders  are  drawn  on  the  proper 
form. 

(b)  The  amount  of  any  one  money  order  does  not 
exceed  the  limit  fixed  by  the  issuing  bank. 

(c)  The  signatures  of  the  officers  on  the  money  or- 
der agree  with  the  specimen  signatures  of  authorized 
signing  officers  on  file. 

(d)  The  money  order  is  presented  for  payment 
within,  say,  twelve  months  of  the  date  of  issue. 
( After  the  expiration  of  this  period  the  money  orders 
are  payable  only  at  the  head  office  of  the  issuing 
bank. ) 

PAYMENT   TO    HOLDERS 

(a)  In  Great  Britain  and  Ireland  the  face  amount 
of  sterling  is  paid  to  the  holder  without  deduction  ex- 
cept for  revenue  stamps  if  the  order  is  drawn  in 
sterling.  Dollar  orders  and  checks  are  paid  at  the 
rate  of  exchange  for  Xew  York  funds  on  the  day  they 
are  presented. 

(b)  In  countries  other  than  Great  Britain  and  Ire- 
land the  equivalent  of  the  dollar  amount  is  paid  to 
the  holder  at  a  rate  of  exchange  which  includes  the 
commission  and  other  charges  of  the  paying  agent. 
In  countries  where  a  revenue  stamp  is  necessary  the 

XVIII— 11 


172  INTERNATIONAL  EXCHANGE 

cost  of  such  stamp  is  charged  to  the  holder  of  the  for- 
eign money  order. 

REDEMPTION 

(a)  Foreign  money  orders  paid  in  Great  Britain 
and  Ireland  are  redeemed  by  the  London,  England, 
branch  or  correspondent  of  the  issuing  bank,  at  the 
face  amount  of  sterling  plus  the  commission  agreed 
upon  if  drawn  in  sterling,  or  at  the  dollar  equivalent 
at  the  rate  of  exchange  on  the  day  of  payment. 

(b)  Foreign  money  orders  paid  in  countries  other 
than  Great  Britain  and  Ireland  are  redeemed  by  the 
London,  England,  branch  or  correspondent  of  the  is- 
suing bank  at  the  dollar  equivalent  at  the  rate  of  ex- 
change on  the  day  of  payment. 

17.  Mail  reviittances. — To  meet  the  requirements 
of  emigrants  and  to  facilitate  the  transfer  of  sums  of 
money  to  places  where  banking  facilities  are  somewhat 
limited,  a  special  class  of  transactions,  called  mail  re- 
mittances, has  been  instituted.  By  this  system  a  bank 
in  one  country  requests  its  chief  correspondent  in  an- 
other country  to  pay  a  certain  sum  to  a  specified  per- 
son in  that  country,  and  incloses  a  draft  in  favor  of 
the  correspondent  to  cover  the  amount  involved  and 
the  correspondent's  commission  (which  is  usually  the 
same  as  for  drafts) .  The  corresi:)ondent  in  the  coun- 
try then  forwards  the  amount  (or  its  equivalent  in 
local  currency)  to  the  beneficiary  by  registered  mail 
or  thru  its  agents  in  the  town  where  the  beneficiary 
resides. 


FOREIGN  REMITTANCES 


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174  INTERNATIONAL  EXCHANGE 

In  order  to  make  sure  that  the  amount  reaches  its 
destination  safely,  the  purchaser  is  furnished  by  his 
bank  with  two  shps,  one  a  receipt  for  the  money  he 
has  paid  and  the  other  a  notice  (with  translations 
thereof  in  various  foreign  languages)  for  transmis- 
sion to  the  beneficiary,  which  instructs  him  (the  bene- 
ficiary) to  communicate  with  the  central  correspond- 
ent if  the  sum  mentioned  thereon  is  not  received  within 
the  course  of  a  fixed  number  of  days.  (See  Fig- 
ure 17.) 

REVIEW 

What  is  a  demand  draft?  Describe  some  of  the  ways  in  which 
drafts  are  paid. 

What  does  a  letter  of  advice  usually  contain? 

How  are  travelers'  checks  redeemed? 

What  is  a  letter  of  indication?     Why  is  it  issued? 

What  kinds  of  letters  of  credit  are  issued?  How  does  the 
holder  secure  payment? 

When  are  paying  agents  of  travelers'  checks  free  from  respon- 
sibility in  cashing  such  checks? 


CHAPTER  XI 

THE  SILVER  STANDARD 

1.  Silver  standard. — A  country  is  upon  the  silver- 
standard  when  its  legal  tender  monetary  unit  consists 
of  a  definite  quantity  of  silver,  free  coinage  being  per- 
mitted. In  such  a  country  the  money  value  of  silver 
coins  is  practically  the  same  as  the  commercial  value 
of  the  bullion  which  they  contain.  In  such  countries 
of  course,  silver  and  money  are  regarded  as  identical, 
just  as  gold  and  money  in  gold  standard  countries  are 
thought  of  as  being  practically  one  and  the  same 
thing. 

Only  one  country  of  commercial  importance  is  now 
upon  the  silver  standard,  namely,  China.  The  subject 
of  silver  exchange,  therefore,  is  not  of  great  impor- 
tance to  the  business  world ;  as  a  middle  term,  however, 
between  the  gold  standard  and  the  paper  standard, 
it  has  far  greater  significance  in  the  exposition  of  the 
principles  underlying  exchange  operations.  In  the 
nineteenth  century  there  was  a  long  and  bitter  con- 
flict between  the  advocates  of  silver  and  gold,  some 
important  nations  being  on  the  silver  basis,  others  on 
the  gold  basis,  and  still  others  on  a  joint  or  bimetallic 
basis,  the  free  coinage  of  both  silver  and  gold  being 
permitted  and  the  coins  of  both  metals  being  legal 
tender.     The  adherents  of  the  gold  standard  tri- 

175 


176  INTERNATIONAL  EXCHANGE 

umphed  over  their  silver  opponents  in  the  latter  half 
of  the  nineteenth  century,  and  in  the  last  thirty  years 
all  the  important  nations  of  the  earth  have  sought  to 
put  their  monetary  systems  upon  the  gold  basis. 

Altho  the  silver  standard  exists  in  only  one  great 
country,  nevertheless  it  is  well  for  the  business 
man  to  understand  the  fundamental  principles  gov- 
erning silver  exchange  and  the  international  move- 
ments of  silver  as  a  commodity,  for  all  gold  standard 
countries  make  large  use  of  silver  in  their  subsidiary 
coinage. 

2.  Silver  mint  jmr, — When  several  countries  of  the 
earth  were  on  the  silver  basis,  exchange  relations  be- 
tween them  were  determined  exactly  as  are  exchange 
relations  between  two  countries  on  the  gold  basis.  In 
the  early  part  of  the  nineteenth  century  the  United 
States,  altho  nominally  on  a  bimetallic  basis,  was 
really  upon  a  silver  basis,  for  gold  coins  were  not  in 
circulation,  being  worth  more  as  bullion  than  as 
money.  At  the  same  time  many  important  nations  of 
the  world,  such  as  Germany,  Russia  and  India,  were 
on  the  silver  basis.  In  those  days  the  mint  par  be- 
tween the  American  silver  dollar  and  the  German 
thaler  was  merely  a  question  of  mathematics,  being 
determined  by  the  quantity  of  silver  in  the  one  as 
compared  with  the  quantity  of  silver  in  the  other. 
That  of  course  is  the  method,  as  has  already  been  ex- 
plained by  which  the  mint  par  between  the  moneys 
of  countries  which  are  upon  the  gold  basis  is  de- 
termined. 


SILVER  STANDARD  177 

3.  No  mint  par  between  countries  on  different 
standards. — When  two  countries  use  different  metals 
as  money,  each  being  freely  coined,  it  is  obvious  that 
there  can  be  no  stable  value  relation  between  their 
coins,  and  therefore  no  mint  par  unless  the  commer- 
cial values  of  the  two  metals  move  up  and  down  in 
absolute  unison.  Of  course,  under  ordinary  condi- 
tions the  values  of  two  commodities  never  move  up 
and  down  together  at  all  times.  Hence  quotations  of 
exchange  between  countries  on  different  standards 
cannot  be  comparable  to  a  mint  par. 

It  is  worth  while  recalling,  however,  that  in  the  old 
days  of  bimetallism  prior  to  1870,  when  many  coun- 
tries were  on  the  joint  standard  of  gold  and  silver,  the 
variations  in  the  value  fluctuations  of  the  two  metals 
were  so  slight  that  for  the  purposes  of  international 
trade  something  like  a  bimetallic  mint  par  did  exist. 
This  is  a  matter  which  has  been  the  subject  of  much 
debate  in  the  last  fifty  years,  but  it  possesses  no  prac- 
tical importance  at  the  present  time  and  therefore  de- 
serves no  further  discussion. 

4.  Exchanges  hetweeri  gold  and  silver  countries, — 
International  trade  between  countries  on  different 
bases  is  hampered  by  uncertainties  that  do  not  exist  in 
the  case  of  trade  between  countries  on  the  same  stand- 
ard, for  in  the  former  case  a  certain  speculative  ele- 
ment or  risk  is  always  present.  When  an  exporter 
in  a  country  on  the  gold  basis  ships  goods  to  a  country 
on  the  silver  basis,  the  price  being  quoted  in  terms  of 
silver,  he  cannot  be  certain  that  silver  will  not  fall  in 

XVIII— 13 


178  INTERNATIONAL  EXCHANGE 

value  with  respect  to  gold  before  he  receives  his  pay. 
He  was  inclined,  therefore,  to  demand  from  his 
customer  a  higher  price  than  he  would  ask  if  he  were 
selling  to  a  customer  in  a  country  on  a  gold  basis.  Or 
else  the  merchant  in  the  gold  country  insisted  upon 
trading  on  the  gold  basis  and  put  the  entire  burden 
of  fluctuating  exchange  on  the  buyer.  In  either  case 
this  risk  operated  to  the  detriment  of  business  men  in 
silver  standard  countries,  and  such  countries  have 
during  the  last  fifty  years  quite  generally  endeavored 
to  place  themselves  upon  the  gold  basis. 

5.  Gold  price  of  silver, — We  have  seen  that  the  ex- 
ports of  a  country  are  stimulated  whenever  its  mone- 
tary unit  is  quoted  below  parity  in  foreign  exchanges, 
and  that  the  opposite  effect  upon  trade  is  exerted 
when  rates  of  exchange  rise.  For  example,  the  French 
franc  was  quoted  at  about  eight  cents  in  March, 
1921.  It  is  obvious  that  American  imports  from 
France  would  tend  to  decline  if  its  gold  value  should 
rise  to  nine  cents,  unless  at  the  same  time  a  corre- 
sponding drop  in  prices  took  place  in  France. 

The  exchange  quotations  between  gold  and  silver 
standard  countries  are  practically  a  reflex  of  changes 
in  the  relative  values  of  the  two  metals.  If  the  gold 
price  of  silver  is  rising,  quotations  of  Chinese  exchange 
will  advance  in  London,  and  vice  versa.  Changes  in 
the  relative  values  of  the  two  metals  have  in  the  past 
produced  important  changes  in  the  currents  of  trade. 
For  example,  during  the  seventies  and  eighties  of  the 
last  century  the  gold  price  of  silver  steadily  declined. 


SILVER  STANDARD  179i 

India  was  then  upon  a  silver  basis  and  her  general 
level  of  prices  did  not  undergo  great  changes.  As  the 
price  of  silver  fell,  it  was  possible  for  English  im- 
porters of  wheat  to  import  that  commodity  from 
India  at  constantly  lessening  expenditm'es  of  gold. 
During  this  period  the  farmers  of  the  United  States 
inspired  by  the  advocates  of  the  free  coinage  of  silver, 
complained  bitterly  because  the  price  of  a  bushel  of 
wheat  was  being  steadily  forced  down  by  competition 
with  a  country  which  had  the  advantage  of  being  on 
the  silver  basis. 

6.  Real  situation  as  to  silver, — Speaking  of  the 
arguments  in  favor  of  the  use  of  silver  which  were 
drawn  from  the  experience  of  India,  Dean  Joseph 
French  Johnson  in  his  "Money  and  Currency"  says: 

To  business  men,  as  well  as  to  farmers  and  producers 
generally,  the  silver  advocate  addressed  an  argument 
based  upon  the  apparent  prosperity  of  India.  India  had 
become  our  chief  competitor  in  the  wheat  markets  of  the 
world.  Until  1893,  her  money  had  been  silver,  and  the 
friend  of  silver  held  that  the  wheat  growers  of  India,  on 
account  of  the  falling  price  of  silver,  had  been  able  to 
undersell  the  farmers  of  the  United  States  at  Liverpool 
year  after  year,  without  themselves  making  any  change 
whatever  in  the  price  of  their  wheat .  The  Indian  exporter 
of  wheat,  who  sold  it  at  from  three  to  four  rupees^  per 
bushel  in  1873,  had  averaged  the  same  price  during  the 
full  twenty  years,  and  with  the  money  he  had  received  he 
had  each  year  been  able  to  buy  about  the  same  quantity 

1  The  rupee  contains  165  grains  of  pure  silver  and  in  1873  was 
equivalent  to  44  cents.  After  1873  its  gold  value  declined,  until  in  1893 
it  was  worth  only  26  cents  in  gold. 


180  INTERN ATIOXAL  EXCHANGE 

of  goods  or  pay  the  same  amount  of  debt ,  for  general  prices 
did  not  rise  in  India  prior  to  1893.  But  four  rupees  of 
silver  after  1873  represented  a  lessening  amount  of  gold, 
so  that  an  American  farmer,  in  order  to  compete  with  the 
Indian  producer,  had  been  obliged  to  lower  his  price 
year  after  year.  Thus,  when  the  price  of  silver  had  fallen 
until  a  rupee  of  165  grains  of  pure  silver  was  worth  only 
30  cents  in  gold,  the  American  farmer  in  order  to  compete 
with  Indian  wheat  at  three  rupees  was  obliged  to  sell  his 
wheat  at  90  cents.  The  advocates  of  the  free  coinage  of 
silver,  using  illustrations  of  this  sort,  argued  that  the 
adoption  of  the  silver  standard  would  give  us  a  tremen- 
dous advantage  over  foreign  nations  using  gold  as  money. 
The  free  coinage  of  silver  would  not  only  have  the  effect 
of  a  protective  tariff,  lessening  our  imports  of  foreign  goods 
but  would  also  stimulate  our  exports  by  giving  our  pro- 
ducers an  advantage  like  that  which  the  producers  of 
India  had  enjoyed. 

As  for  the  argument  based  on  India's  apparent  command 
of  the  wheat  markets  of  the  world  after  1873,  that  also 
contained  several  grains  of  truth.  If  two  competing  coun- 
tries are  using  different  monetary  standards,  say  silver 
and  gold,  a  change  in  the  value  relation  between  the  two 
metals  will  give  a  temporary  stimulus  to  the  exports  of 
that  nation  whose  money  metal  is  falling  in  value  with  re- 
spect to  the  other.  This  stimulus  is  due  to  the  maladjust- 
ment of  prices  that  always  accompanies  a  change  in  the 
value  of  a  money  metal.  \Mienever  the  value  of  silver 
falls  in  Europe  or  the  United  States  because  of  an  increas- 
ing supply  or  diminished  demand,  the  decline  is  indicated 
by  a  fall  of  the  gold  price  of  silver  before  the  general  price 
level  in  silver-standard  countries  has  been  much  affected. 
Before  1893,  for  example,  a  decline  in  the  price  of  silver 
in  Europe  could  not  affect  prices  in  India  until  additional 
silver  had  been  added  to  India's  money  supply  and  put 
into  circulation  among  the  people.  Consequently,  when 
the  gold  price  of  silver  fell  because  of  a  fall  in  the  value  of 
that  metal  the  producers  of  India  were  under  no  induce- 


SILVER   STANDARD  181 

merit  on  that  account  to  charge  higher  prices  for  their 
goods,  for  their  money  costs  of  production  had  not  in- 
creased. An  ounce  of  silver  meant  as  much  to  them  as  it 
had  meant  before  the  decHne  of  the  London  or  New  York 
quotation  for  silver;  but  since  it  now  took  less  gold  to  buy 
an  ounce  of  silver,  it  was  possible  for  Europeans  to  buy  a 
given  quantity  of  India's  products  with  less  gold  than  for- 
merly. In  consequence  American  and  European  pro- 
ducers who  were  competing  with  Indian  producers  were 
obliged  to  lower  their  prices,  altho  the  only  cause  therefor 
seemed  to  be  a  change  in  the  relation  between  gold  and 
silver. 

Such  a  condition  wouid  of  course  oe  temporary  unless 
the  fall  in  the  value  of  silver  were  continuous.  India 
would  increase  her  exports  until  a  balance  had  been 
created  requiring  an  importation  of  silver  sufficient  to 
raise  her  price  level  to  parity  with  the  value  of  silver  in 
Europe  and  the  L^nited  States.  Thus  when  the  value  of 
silver  was  falling  India's  exports  of  goods  were  always  a 
little  larger  than  they  otherwise  would  have  been,  the  ex- 
cess representing  the  value  which  India  gave  to  the  world 
in  payment  for  the  additional  silver  required  in  her  cir- 
culation. 

^Mien  the  gold  price  of  silver  fell  because  of  a  rise  in  the 
value  of  gold,  as  most  commonly  happened  between  1873 
and  1893,  the  effect  upon  India's  export  trade  was  more 
apparent  than  real  or  permanent,  and  was  due  to  the  mal- 
adjustment of  prices  in  gold-using  countries.  AYhen  the 
gold  price  of  silver  changes,  exporters  and  importers  are 
usually  unaware  of  the  cause  and  do  not  seek  to  discover 
it;  it  is  commonly  assumed  in  gold-using  countries  that 
the  value  of  silver  has  fallen,  and  in  silver  countries  that 
the  value  of  gold  has  risen .  So  whenever  the  gold  price  of 
silver  fell  after  1873,  whatever  the  cause,  the  first  effect 
was  always  the  same,  namely,  importers  in  gold  countries 
were  able  to  get  goods  from  India  by  the  expenditure  of 
less  gold  than  before  the  fall,  and  consequently  American 
and  European  producers  in  competition  with  India  were 


182  INTERNATIONAL  EXCHANGE 

obliged  to  lower  their  prices.  But  when  the  change  was 
due  to  a  rise  in  the  value  of  gold,  the  value  of  silver  not 
declining,  there  was  no  reason  why  India  should  import 
an  unusual  amount  of  silver,  for  India  did  not  then  need 
any  addition  to  her  money  supply.  Nevertheless  the  ex- 
porters of  India  had  a  temporary  advantage  in  the  world's 
markets.  Without  any  sacrifice  they  were  able  to  cut 
under  the  gold  price  which  had  prevailed  for  the  same 
goods.  But  their  advantage  could  be  only  temporary,  for 
prices  in  the  gold  countries,  since  gold  was  increasing  in 
value,  soon  fell  to  a  level  which  placed  the  European  and 
the  American  exporter  on  a  par  with  the  Indian  exporter. 
Any  long  delay  in  the  adjustment  of  prices  in  gold  coun- 
tries would  continue  India's  advantage  and  give  her  an 
unusual  balance  of  trade,  but  the  resultant  importation  of 
silver  would  lift  her  price  level  and  so  deprive  her  exporters 
of  their  advantage  over  exporters  in  gold  countries.  In 
fact  such  an  importation  of  silver,  after  prices  in  gold  coun- 
tries had  become  adjusted  to  the  new  value  of  gold,  would 
put  Indian  exporters  at  a  disadvantage  for  a  time  and 
perhaps  cause  an  exportation  of  silver. 

7.  Silver  and  international  eoochange. — Altho  seri- 
ous consideration  of  the  adoption  of  a  bimetallic 
standard  has  practically  disappeared  during  the  last 
tw^enty  years,  silver  continues  to  exert  a  powerful 
influence  in  international  exchange.  The  flurry  in  the 
price  of  silver  that  followed  the  war  has  only  served 
to  re-emphasize  the  importance  of  the  metal.  There 
is  only  one  commercially  important  country  left  in 
which  silver  is  the  standard  of  value — the  only  legal 
tender — namely  China,  but  the  close  relation  of  the 
metal  to  money  and  exchange  is  maintained  by  its 
world  wide  use  as  subsidiary  coinage.  Moreover  all 
the  Far  Eastern  countries  maintain  a  consuming  de- 


SILVER  STANDARD  183 

mand  for  silver.  Xor  is  the  expression  "consuming 
demand"  a  mere  figure  of  speech  in  this  case.  Refer- 
ence is  constantly  being  made  to  the  'Voracious  appe- 
tite" of  China  for  the  precious  metal  and  India  is 
characterized  as  a  "bottomless  pit."  The  silver  de- 
mand of  these  countries  is  due  to  the  use  of  vast  quan- 
tities for  hoarding,  for  ornaments  (especially  in 
India),  and  for  currency  purposes.  The  latter  use 
has  for  many  years  been  the  principal  factor  in  the 
demand,  but  more  recently  hoarding  is  believed  to 
have  gone  on  to  a  vastly  increased  extent.  It  remains 
an  undisputed  fact  that  silver  that  once  goes  into 
China  or  India  seldom  comes  out  again.  Conserva- 
tive estimates  place  the  amount  absorbed  by  India 
between  1914  and  1920  at  500,000,000  ounces  and 
China  during  the  same  time  bought  fully  400,000,000 
ounces  of  bar  silver. 

War  conditions  brought  about  an  increased  demand 
for  subsidiary  coinage  thruout  the  world.  War  in- 
dustries were  extended  to  the  silver  using  countries  of 
the  East.  The  soldiers  of  all  the  warring  nations 
used  large  quantities  of  subsidiary  coin  and  all  troops 
in  East  Africa  and  Mesopotamia  had  to  be  paid  in 
silver.  The  allied  nations  were  buying  the  products 
of  the  Far  East  in  immense  quantities  and,  as  every 
nation  was  conserving  its  gold  supply,  they  soon  be- 
came heavy  buyers  in  the  silver  market.  Industrial 
use,  in  which  the  manufacture  of  moving  pictures  is 
the  chief  factor,  continued  to  require  about  70,000,000 
fine  ounces  a  year.     All  these    conditions    brought 


184  INTERNATIONAL  EXCHANGE 

about,  between  1914  and  1920,  price  fluctuations  of 
silver  that  were  unprecedented. 

8.  Asias  historic  influence. — One  of  the  reasons 
which  no  doubt  has  contributed  to  the  scanty  atten- 
tion paid  to  the  subject  of  Eastern  exchange  is  the 
fact  that  few  people  have  realized  until  recently  the 
very  important  influence  that  the  East  has  exercised 
from  the  beginning  of  history,  and  will  undoubtedly 
continue  to  exercise,  on  the  economic  life  of  the  West, 
or  so-called  civilized  world.  Asia  has  always  exerted 
a  passive  influence  on  human  enterprise,  due  in  a 
great  measure  to  her  insatiable  appetite  for  the  pre- 
cious metals.  Three  thousand  years  before  the  Chris- 
tian Era  the  Phoenicans  ranged  far  afield  to  Spain 
and  distant  Britain  in  search  of  gold  and  silver  with 
which  to  maintain  their  trade  with  the  Orient  for  silk, 
spices  and  other  luxuries.  Later  the  Venetians 
gained  control  of  the  caravan  routes  to  the  East,  and 
further  depleted  the  European  supply  of  the  precious 
metals.  This  immensely  lucrative  trade  of  Venice 
aroused  the  envy  of  Portugal  and  Spain,  and  inspired 
voyages  of  discovery  and  the  search  for  a  sea  route 
to  the  East  which  resulted  in  the  discovery  of  America 
by  Columbus,  and  Vasco  da  Gama's  successful  voy- 
age around  the  Cape  of  Good  Hope.  The  discoveries 
came  at  an  opportune  time.  The  gold  and  silver  mines 
of  Europe  were  practically  exhausted  and  there  was  no 
other  source  of  supply.  The  trade  with  the  Orient 
thru  Venice  was  a  steady  drain  on  a  constant^  di- 
minishing stock,  and  the  shortage  of  precious  metals 


SILVER  STANDARD  18o 

as  a  medium  of  exchange  had  long  acted  as  a  deterrent 
on  the  industrial  and  economic  progress  of  Europe. 
The  flow  of  gold  and  silver  to  Spain  from  America 
gave  Europe  the  long  wanted  impetus,  which  enabled 
her  to  throw  off  the  fetters  of  the  Middle  Ages  and 
brought  about  a  revival  of  learning  and  industry  in 
every  branch  of  human  activity. 

9.  How  silver  is  marketed. — A  second  outstanding 
reason  for  the  general  lack  of  knowledge  regarding 
Eastern  exchange  is  the  result  of  the  way  in  which 
silver  has  been  marketed.  The  operations  have  been 
in  the  hands  of  a  few  highly  trained  experts. 

London  for  several  centuries  has  been  the  chief 
market  for  silver,  owing  in  a  great  measure  to  her 
long  and  intimate  connection  with  the  Eastern  trade, 
first  established  by  the  old  East  India  Company,  and 
since  maintained  and  increased  by  direct  marine  serv- 
ice and  other  well  established  interests.  The  course 
of  Eastern  exchange  rests  almost  entirely  on  the  price 
of  silver,  the  market  for  which,  for  several  genera- 
tions, has  been  principally  in  the  hands  of  four  Lon- 
don firms,  as  follows;  Mocatta  &  Goldsmid,  Samuel 
Montague  &  Company,  Pixley  &  Abell  and  Sharp  & 
Wilkins.  The  first  mentioned  firm  dates  back  to 
1684,  ten  years  before  the  Bank  of  England  was 
founded.  Before  the  war  these  four  firms  determined 
the  price  of  silver  at  a  certain  hour  each  day — 1.45 
p.  M.  (Saturday  11.45  a.  m.)  and  the  bulk  of  the 
world's  transactions  in  silver  was  based  on  this  price, 
wliich  in  turn  established    the  rate    of  Eastern    ex- 


186  INTERNATIONAL  EXCHANGE 

change,  the  actual  operation  of  which  hes  principally 
in  the  hands  of  the  great  Anglo-Asiatic  banks,  The 
Hongkong  &  Shanghai  Banking  Corporation,  The 
Chartered  Bank  of  India,  Australia  &  China,  and 
The  Mercantile  Bank  of  India,  Limited.  Exchange 
operations  under  these  conditions  required  a  highly- 
specialized  knowledge,  not  only  of  the  silver  market, 
but  also  of  Eastern  conditions  themselves,  and  were 
practically  confined  to  highly  trained  employees  of 
the  banks  and  brokers  above-mentioned.  Intensive 
information  therefore  was  only  available  to  those  ac- 
tually engaged  in  the  operations.  These  men  were 
evidently  too  busy,  or  not  of  a  sufficiently  literary 
turn  of  mind  or  inclination,  to  place  their  experience 
or  knowledge  on  record. 

A  change  in  the  market  methods  seemed  to  be  fore- 
shadowed in  1917.  In  September  of  that  year  the 
United  States  controlled  silver  and  did  not  permit  its 
export  except  under  license.  In  April,  1918,  the 
Pittman  Act  came  into  force,  and  for  a  time  was  re- 
garded as  a  most  important  piece  of  legislation.  This 
act  authorized  the  sale  of  silver  not  exceeding  350,- 
000,000  silver  dollars  from  the  silver  reserve  of  the 
United  States.  Out  of  this,  the  equivalent  of  270,- 
000,000  fine  ounces,  the  share  of  India  was  200,- 
000,000  fine  ounces,  which  was  bought  by  the  British 
Government  and  imported  into  India  in  the  follow- 
ing year.  The  act  further  stipulates  that  silver  sold 
under  its  provision  shall  be  replaced  by  purchases 
made  at  the  fixed  price  of  $1.00  per  fine  ounce,  and 


SILVER   STANDARD  187 

that  the  metal  so  purchased  must  be  "the  product  of 
mines  situated  in  the  United  States  and  of  reduction 
works  so  located."  As  is  usually  the  case  with  legis- 
lation that  tries  to  combat  economic  laws,  other  than 
its  action  in  placing  a  possible  bonus  on  silver  mined 
in  the  United  States,  the  only  result  of  its  provisions 
has  been  to  establish  two  separate  and  distinct  markets 
and  quotations.  In  the  United  States,  domestic  com- 
mercial silver  is  virtually  pegged  at  99^  cents.  For- 
eign silver  is  also  quoted  on  the  Xew  York  market, 
but  moves  with  the  London  price,  which  has  returned 
to  its  position  as  arbiter  of  the  silver  exchange  rates. 

10.  The  silver  price  flurrij. — The  statistics  of  the 
world's  annual  production  of  silver  show  that  an 
astonishing  decrease  has  taken  place  since  1913. 
Nearly  234,000,000  fine  ounces  were  produced  in  that 
year.  In  1914  only  about  160,600,000  ounces  were 
mined,  and  altho  production  has  increased  beyond 
that  amount  in  later  years,  the  1920  figures  show  it 
to  be  still  far  below  normal.  Simultaneously  with 
this  decrease  in  production  came  the  great  increase  in 
demand,  the  reasons  for  which  were  outlined  in  an 
earlier  section. 

Erratic  is  the  mildest  word  that  can  be  applied  to 
the  market  between  1915  and  the  end  of  1920.  In 
midsummer  of  1915  the  monthly  average  price  of  sil- 
ver fell  to  481/0  cents  per  fine  ounce,  which  is  the 
lowest  point  it  has  touched  since  definite  records  were 
established.  Thereafter  the  price  rose  gradually  to 
about  $1.00  per  fine  ounce  in  May,  1918,  and  main- 


188  INTERNATIONAL  EXCHANGE 

tained  that  level  during  a  year  of  United  States  gov- 
ernmental regulation.  In  May,  1919,  a  rapid  ad- 
vance began  which  carried  the  price  to  the  record  high 
point  of  $1,371/2  in  November,  1919.  The  average 
monthly  price  in  January,  1920,  was  the  highest  ever 
recorded,  but  in  March  a  sharp  turn  downward  oc- 
curred, and  silver  fell  to  80  cents  on  June  15th. 
Thereafter  the  price  rose  until  a  figure  over  $1.00 
was  reached  on  August  20th.  Decline  again  set  in 
and  before  the  end  of  the  year  foreign  silver  was 
quoted  on  Xew  York  market  at  76^/8  cents  an  ounce. 

A  money  metal  which  sells  at  $1.37^  per  ounce  in 
January,  at  80  cents  in  June,  $1.01%  in  August  and 
761/4  in  October,  may  be  considered  an  economic  curi- 
osity, even  in  a  year  of  such  wild  fluctuations  as  these 
of  1920.  If,  for  example,  the  American  silver  dollar 
had  been  the  actual  standard  of  value  for  the  United 
States  currency,  its  bullion  value  would  have  moved 
from  $1.06  to  62  cents,  back  to  78%  cents,  and  down 
again  to  59  cents,  which  would  fairly  rival  the  vicissi- 
tudes of  the  German  mark. 

11.  Effects  on  Eastern  exchange. — The  decline  in 
the  price  of  silver  has  naturally  had  an  eff'ect  on  the 
Eastern  exchanges.  China  in  particular  suffered  in 
this  movement,  and  there  is  little  doubt  that  a  num- 
ber of  Chinese  financiers  who  were  speculating  in 
silver  sustained  huge  losses.  Taking  three  dates  for 
which  quotations  are  available,  we  find  that  on  Feb- 
ruary 16th,  1920,  when  the  price  of  silver  in  the  Lon- 
don market  was  831/8  pence,  the  value  of  the  Shang- 


SILVER   STANDARD  189 

hai  tael  was  9  shillings  and  3  pence  in  London;  on 
March  24th,  when  the  price  of  silver  had  fallen  to 
7ll/>  pence,  the  value  of  the  tael  had  also  fallen  and 
it  was  worth  only  7  shillings  and  5  pence.  The  de- 
chne  in  the  value  of  the  tael  kept  pace  with  the  de- 
cline in  the  price  of  silver,  until  on  June  9th,  when 
silver  had  fallen  to  45%  pence,  the  tael  had  fallen 
to  4  shillings  and  10  pence. 

12.  Silver  melting  points. — The  relation  of  the  so- 
called  melting  points  of  silver  coinage  to  interna- 
tional exchange  has  been  clearly  demonstrated  during 
the  reconstruction  period.  All  nations  use  silver  as 
subsidiary  money  and,  with  the  exception  of  the 
United  States  silver  dollar,  all  such  coins  are  token 
money.  With  silver  at  its  pre-war  price  the  token 
coins  of  Europe  and  America  were  worth  more  as 
money  than  as  commercial  silver.  This  condition  was 
the  result  of  deliberate  intention  of  the  governments. 
The  United  States  silver  dollar  was  the  one  excep- 
tion. It  was  designed  to  be  a  standard  coin,  not  a 
token,  and  therefore  contained  an  amount  of  silver 
(at  the  old  price)  that  very  closely  approximated  its 
face  value. 

As  the  price  of  bullion  silver  rises  all  these  well 
planned  schemes  are  disrupted.  When  silver  sells 
for  733/3  pence  per  ounce  in  London,  all  British  silver 
coins  are  worth  as  much  as  commercial  silver  as  they 
are  as  money.  If  the  price  of  the  metal  goes  higher, 
it  will  pay  to  melt  small  coins  and  sell  the  bar  silver. 
Consequently   733^3  pence   per   ounce   is   called   the 


190  INTERNATIONAL  EXCHANGE 

"melting  point"  for  British  silver  coins.  In  the 
United  States  the  melting  point  for  token  coinage  is 
$1.38  +  per  ounce  for  silver  and  that  of  the  standard 
silver  dollar  is  reached  when  $1.29  +  per  ounce  can 
be  obtained  for  the  metal. 

As  the  price  of  silver  rose  in  Europe  during  the 
war,  because  of  the  insatiable  demands  of  the  Orient, 
both  England  and  France  were  forced  to  put  em- 
bargoes on  its  exportation.  This,  however,  failed  to 
produce  the  desired  result,  for  the  price  of  silver  went 
far  beyond  the  melting  points  and  subsidiary  coinage 
began  to  disappear  at  an  alarming  rate.  The  ex- 
change rates  which  were  adverse  to  Europe  only  ac- 
celerated this  disappearance  of  silver  from  circula- 
tion. A  pound  sterling  would  purchase  only,  say 
80  per  cent  of  its  normal  value  in  New  York,  while  a 
hundred  francs  would  be  worth  only  50  per  cent  of 
their  par  value  in  dollars.  On  the  other  hand,  the 
silver  coinage  of  either  country  would  bring  in  'New 
York  not  only  its  full  value  as  money,  but  a  premium 
that  grew  to  be  of  very  considerable  size  as  silver 
reached  its  highest  prices.  The  greater  the  discount 
at  which  the  European  currencies  were  quoted,  the 
more  likely  was  silver  to  disappear.  Silver  coins  had 
largely  gone  from  circulation  in  Continental  Europe 
in  1920  and  the  quantity  in  Great  Britain  was  ma- 
terially reduced.  In  the  United  States  this  effect 
of  high  priced  silver  was  not  felt,  altho  no  doubt  a 
good  many  silver  coins  were  melted  down  during 
1920.     Canada  protected  her  subsidiary  coinage  by 


SILVER   STANDARD  191 

reducing  slightty  its  silver  content  and  thus  raising 
the  melting  point. 

13.  Silver  standard. — The  silver  standard  exists  in 
a  country  where  it  is  enacted  by  law  that  silver  alone 
shall  be  legal  tender  and  the  measure  of  value.  China, 
as  we  have  already  noted,  is  now  the  only  country  of 
commercial  importance  that  retains  the  silver  stand- 
ard. This  fact  has  not,  however,  altered  the  position 
of  silver  in  the  Far  East.  Gold  standards  are  theoret- 
ically in  force  in  Siam,  French  Indo-China,  Straits 
Settlements,  British  Xorth  Borneo,  The  Federated 
Malay  States,  Sarawak  and  India,  but  silver  is  the 
only  currency  in  use.  Siam's  gold  standard  coin  is 
the  dos  (or  ten  tical  piece),  but  none  has  yet  been 
issued.  The  colonial  government  of  French  Indo- 
China  fixes  the  rate  of  exchange  between  the  piastre 
or  dollar,  and  the  franc,  thus  giving  the  colonj^  the 
gold  standard  of  France.  The  Straits  Settlements, 
British  Xorth  Borneo,  The  Federated  Malay  States 
and  Sarawak  all  use  the  same  silver  currency,  which 
is  maintained  in  a  fixed  ratio  to  the  pound  sterling. 
In  each  of  these  countries  the  notes  of  the  four  Anglo- 
Asiatic  banks  circulate  with  considerable  freedom, 
and  in  certain  places  are  preferred  to  the  local  paper 
issues  which  are,  nevertheless,  well  supported  and 
wisely  administered  paper  currencies.  The  domestic 
trade  of  these  countries  is  regulated  by  the  bullion 
price  of  silver,  but  all  outside  transactions  are  based 
on  gold,  and  in  the  end  the  value  of  silver  is  thus  reg- 
ulated bv  these  international  transactions. 


192  INTERNATIONAL  EXCHANGE 

The  following  are  the  principal  coins  used  in  these 
countries : 

Grammes  Grammes 

Name  Fineness  gross  fine 

British   Dollar 900  26.9569  24.2612 

Mexican   Dollar 902.7  27.073  24.4388 

Maria  Theresa 833  1/3  28.0668  23.3889 

Straits  Settlements  Dollar 900  20.2177  18.1958 

Indo-China  Dollar  (or  piastre) 900  27.000  24.300 

Chinese  Republican  Dollar  or  "Yuan" 900  26.8567  24.171 

India  Rupee 916  2/3  11.664  10.692 

Maria  Theresa  Dollar.  This  is  a  trade  coin  (one 
without  the  obligation  of  redemption)  minted  at  Vi- 
enna, but  not  used  in  Austria.  It  is  current  with  full 
legal  tender  value  in  Abyssinia,  Arabia,  East  Coast 
of  Africa,  Eritrea,  Oman,  Persian  Gulf  countries, 
Tripoli,  and  countries  of  the  Eastern  Mediterranean 
and  Asia  Minor.  This  coin  has  almost  disappeared 
from  Far  Eastern  circulation  since  1914. 

Mexican  Peso. — This  coin,  also  called  "Mexican 
Dollar,"  is  full  legal  tender  in  Hongkong  and  China. 
It  is  preferred  by  the  Chinese  to  the  coins  minted  by 
themselves. 

British  Dollar. — This  coin  was  created  in  1894  in 
response  to  the  great  demand  for  currency  in  the  Far 
East.     It  is  legal  tender  in  Hongkong  and  Labuan. 

Indo-China  Piastre. — This  coin  was  introduced  by 
the  French  Government  to  help  commerce  in  her 
Asiatic  colonies.  It  is  modelled  after  the  Mexican 
dollar,  and  is  accepted  as  equivalent  to  the  latter  coin. 

Straits  Settlements  Dollar. — This  coin  was  origin- 
ally minted  for  circulation  only  in  the  Straits  Settle- 


SILVER   STANDARD  19S 

ments,  but  has  become  current  in  British  North  Bor- 
neo, The  Federated  Malay  States  and  Sarawak.  It 
has  a  fixed  value  of  2  shillings  and  4  pence  and  is  only 
given  here  for  purposes  of  comparison  as  the  Straits 
Settlements  are  on  a  gold  exchange  basis. 

Trade  Dollar. — This  dollar  was  coined  by  the 
United  States  to  compete  with  the  Mexican  dollar  in 
trade  with  China  and  the  Far  East.  It  had  no  status 
within  the  United  States  and  has  been  withdrawn 
from  circulation.  Any  still  outstanding  have  only 
a  bullion  value. 

14.  Eastern  exchange. — In  all  these  countries  we 
are  now  considering,  exchange  is  either  regularly 
quoted,  or  can  be  negotiated,  on  the  following  coun- 
tries or  cities:  Great  Britain,  France,  Spain,  Hong 
Kong,  Singapore,  Xew  York,  San  Francisco,  Van- 
couver, Japan,  Shanghai,  Amoy,  Saigon  and  India, 
For  many  years  the  rate  for  telegraphic  transfer  on 
London  has  governed  the  rates  on  "sight"  and  "4 
months'  sight"  bills  common  in  the  East.  This  cus- 
tom may  still  be  regarded  as  in  force,  tho  the  rate  of 
telegraphic  transfer  on  San  Francisco  or  Vancouver, 
has  within  the  last  couple  ot  years  exerted  an  influ- 
ence on  the  general  rates. 

15.  Currency  of  China. — China  is  the  oldest  and 
most  important  of  the  silver  standard  countries  and 
the  ancient  unit,  the  tael  or  liang,  continues  to  be 
used.  A  tael  is  actually  a  weight  and  not  a  coin  and 
circulates  in  the  form  of  shoes,i  or  of  small  bars.    This 

1  From  resemblance  in  shape  to  a  Chinese  woman's  shoe. 

XVTII — 14 


194  INTERNATIONAL  EXCHANGE 

unit  is  not  fixed  in  any  way.  In  different  cities  and 
provinces  it  varies  in  weight  and  in  fineness  of  silver. 
Actually  there  are  no  silver  ingots  of  one  tael;  the 
ingots  usually  weigh  from  7  to  10  taels  and  are  called 
sycee  from  the  Chinese  "Sai  ssu,"  meaning  fine  silver. 
The  variation  in  weight  in  the  sixteen  best  known 
kinds  of  tael  is  from  37.5317  grammes  of  fine  silver 
in  the  Hai  Kwan  tael  to  34.0732  grammes  fine  in  the 
Swatow  tael.  The  Hai  Kwan  (or  customs)  tael  is 
the  most  important.  It  is  generally  rated  at  72  per 
100  Mexican  dollars.  The  official  tael  agreed  upon 
by  treaty  is  the  Kuping  or  Treasury  tael  divided  into 
100  cents  of  10  mills  each.  This  unit  weighs  37.313 
grammes  .980  fine  and  contains  36.56674  grammes  of 
fine  silver.  The  Chinese  monetary  system  has  been 
still  further  complicated  by  the  series  of  revolutions 
the  country  has  been  passing  thru.  There  have  re- 
cently been  issued  four  different  mintings  of  republi- 
can dollars  weighing  26.8567  grammes  900  fine.  The 
Mexican  dollar  also  circulates  freely.  Many  of  the 
silver  coins  are  stamped  or  "chopped."  This  prac- 
tice arose  from  the  fact  that  many  light  and  debased 
coins  were  formerly  in  circulation,  and  having  once 
established  the  value  of  a  coin  the  Chinese  merchant 
or  banker  marked  it,  not  only  that  he  might  recognize 
it  again  but  so  that  others  to  whom  his  "chop"  was 
familiar  might  accept  it  confidently.  The  result  of 
much  chopping  has  been  to  mutilate  and  debase  a 
very  considerable  part  of  the  silver  coinage  in  cir- 
culation. 


SILVER  STANDARD  195 

Like  the  tael,  the  mace  and  candareen  are  simply 
denominations  representing  certain  fixed  weights  of 
silver.  The  weights  and  value  vary  according  to  the 
location.  All  domestic  business  is  transacted  in 
"cash,"  a  coin  of  varying  weight,  size  and  metals  con- 
tained, but  of  fairly  constant  local  value,  which  is  of- 
ficially considered  to  be  at  the  rate  of  about  1000  to 
the  United  States  dollar. 

The  value  of  the  various  taels  moves  with  the  price 
of  silver,  and  it  is  impossible  to  give  a  fixed  equiva- 
lent, but  it  is  easily  ascertained  by  multiplying  the 
amount  of  fine  silver  in  the  tael  by  the  price  of  an 
ounce  or  a  gramme  of  fine  silver.  The  Shanghai  tael 
weighs  about  11-6  ounces  of  standard  silver  (.925 
fine) .  The  Kuping  tael,  for  instance,  weighs  1.175625 
ounces  of  fine  silver. 

The  monetary  system  established  in  Hong  Kong 
and  Labuan  by  the  British  Government  is  silver 
standard  and  has  as  its  base  or  standard  coin  the 
Mexican  dollar  weighing  27.073  grammes  (902.7 
fine)  or  24.4388  grammes  fine  silver.  The  British 
dollar  (24.2612  grammes  of  fine  silver)  is  treated  as 
equal  to  the  Mexican  dollar  and  both  are  legal  tender 
to  any  amount. 

16.  Chinese  eocclianges, — From  the  foregoing  facts 
it  may  easily  be  surmised  that  the  operation  of  ex- 
change with  China  is  a  complicated  matter,  and  is 
best  dealt  with  by  those  who  have  made  a  life  study 
of  the  East  and  its  customs.  The  rates  of  exchange 
rise  and  fall  with  the  price  of  silver,  and  owing  to  the 


196  IXTERXATIOXAL  EXCHANGE 

violent  variations  in  these  rates  the  business  is  a  highly 
specialized  one.  Quotations  and  drawing  facilities 
on  the  Orient  are  usually  provided  by  one  of  the 
Anglo-Asiatic  banks.  Rates  for  all  the  customary 
forms  of  bills  are  governed  by  those  of  telegraphic 
transfers  on  London.  The  latter  are  arrived  at  by  a 
computation  based  upon  the  degree  of  fineness  of  bar 
silver  imported  into  China  in  comparison  with  that  of 
British  standard  silver. 

The  usual  forces  of  supply  and  demand  for  bills  of 
exchange  exert  the  same  pressure  here  as  elsewhere 
and  rates  are  consequently  "at,  above,  or  below  par." 
It  works  out,  therefore,  that  this  expression  as  applied 
to  Chinese  exchange  refers  to  the  cost  at  which  silver 
can  be  bought  in  London  or  Xew  York  and  delivered 
in  Shanghai,  all  charges  included. 

REVIEV 

Why  cannot  a  mint  par  of  exchange  be  computed  between  a 
gold  using  and  a  silvcT  using  country? 

What  effect  has  the  gold  price  of  silver  in  the  exchanges  ? 

Discuss  the  advantages  and  disadvantages  of  the  silver 
standard. 

Describe  recent  variations  in  silver  prices  and  discuss  their 
causes. 

When  does  a  rising  price  of  silver  menace  the  subsidiary  coin- 
age of  gold  standard  countries  .^ 


CHAPTER  XII 

FIAT  OR  IRREDEEMABLE  PAPER  MONEY 

1.  Money  and  the  war. — The  war  plunged  the 
leading  commercial  nations  of  Europe  into  a  chaos 
of  inconvertible  paper  money,  comparable  to  that  of 
the  French  Revolution,  when  a  washerwoman  was  not 
even  decently  paid  unless  her  homeward  load  of  paper 
"assignats"  filled  the  basket  in  which  she  had  carried 
the  laundry  to  her  customer.  As  a  result  of  the  ex- 
cessive issues  of  bank  and  government  notes  gold  dis- 
appeared from  circulation  in  the  belligerent  countries 
of  Europe,  and  the  gold  value  of  the  paper  money  de- 
preciated, until  a  paper  pound  had  fallen  in  its  gold 
value  from  $4.86  2/3  to  $3.20,  the  French  franc  from 
19.3  cents  to  less  than  7  cents,  and  the  German  mark 
from  24  cents  to  less  than  2  cents,  while  the  value  of 
the  Russian  rouble,  nominally  about  50  cents,  reached 
the  vanishing  point. 

The  well  known  English  economist.  Professor  Ed- 
win Cannan,  in  the  introduction  to  "The  Paper 
Pound  of  1797-1921"  (pubhshed  in  1919)  makes  the 
following  interesting  comment  on  the  depreciation  of 
the  paper  currencies  of  Europe  after  1914,  as  com- 
pared with  the  depreciation  of  the  paper  pound  ster- 
ling during  the  Napoleonic  Wars: 

197 


198  INTERNATIONAL  EXCHANGE 

In  the  comparatively  short  war  of  1914-18  currencies 
"not  convertible  at  will  into  a  coin  which  is  exportable" 
(Report,  p.  17)  were  issued  by  Governments  and  Govern- 
ment banks  in  amounts  compared  with  which  the  100 
percent  increase  in  thirteen  years,  which  made  the  Bullion 
Committee  complain  so  vigorously  in  1810,  looks  abso- 
lutely trifling.  The  British  Government  brought  out  an 
entirely  new  issue  of  £l  and  10s.  notes  and  increased  it  to 
293  millions  at  the  date  of  the  armistice:  the  Bank  of 
France  increased  its  issue  from  6,000  million  francs  to 
30,500  millions:  the  Italian  increase  was  from  2,500 
millions  to  over  8,000.  The  precise  increase  in  Germany 
and  Austria-Hungary  is  obscure  but  understood  to  have 
been  much  greater.  The  record  since  the  armistice  is  still 
less  of  a  kind  to  give  the  present  day  Europeans  ground 
for  boasting  themselves  better  than  their  fathers.  In 
twenty-three  weeks  the  British  Government  had  increased 
the  note  issue  by  59  millions  more,  and  the  total  still  stood 
on  October  1,  1919,  at  335  millions.  The  French  issue 
on  October  2  was  36,250  millions,  the  Italian  in  July,  1919, 
was  about  10,000  millions  and  the  Russian  rouble  is  being 
manufactured  in  numbers  w^hich  suggest  astronomers* 
calculations  rather  th?  i  anything  terrestrial. 

The  result  is  what  Horner  and  the  Bullion  Committee 
feared.  The  pound  in  October  1919  will  buy  just  about 
the  same  amount  of  gold  as  it  would  when  the  Bullion 
Committee  sat  in  1910,  that  is,  about  107  grains  instead 
ofithe  normal  1233^,  but  it  is  respectable  compared  with 
its  colleagues  in  Europe:  the  franc  will  buy  about  3^/2  in- 
stead of  nearly  5  grains:  the  case  of  the  lira  is  rather  worse; 
the  mark  will  buy  little  more  than  1  grain  instead  of  6; 
the  Austrian  krone  and  the  Russian  rouble  are  worse. 
Politicians  have  certainly  egregiously  failed  to  "advert  to 
the  foreign  exchanges  and  the  price  of  bullion  in  regulating 
their  issues":  instead  they  amuse  their  ignorant  subjects 
with  fantastic  explanations  of  the  perversity  of  the  ex- 
changes and  chimerical  schemes  for  "correcting"  them  by 
stopping  imports  or  borrowing  still  more  from  abroad. 


IRREDEEMABLE   PAPER  MONEY  199 

No  one  can  contend  that  these  paper  standards  are  su- 
perior to  the  gold  standard.  In  the  first  place  they  are 
all  different,  and  in  the  second  the  one  common  property 
that  they  possess  in  all  making  prices  much  higher  than 
they  would  be  if  paper  and  gold  had  not  diverged,  marks 
them  as  all  inferior.  Gold  has  been  produced  in  almost 
the  usual  quantities  thruout  the  war,  it  is  almost  alone 
among  metals  in  not  having  been  used  in  the  manufacture 
of  munitions  of  war,  and  it  has  been  thrown  out  of  cur- 
rency use  over  a  wide  area.  Consequently  it  is  greatly 
depreciated  as  against  commodities:  that  is,  1233^  grains 
of  gold  or  any  freely  exportable  gold  coin  will  buy  far  less 
of  ordinary  commodities  than  before  the  war — perhaps 
scarcely  half.  Consequently  each  of  the  particular  local 
divergencies  between  paper  and  gold  simply  constitutes 
a  local  aggravation  of  a  world-wide  rise  of  prices,  a  great 
part  of  which  is  itself  produced  by  the  general  introduction 
of  the  paper  currencies. 

WTien  the  scales  at  last  fall  from  the  eyes  of  the  people 
of  Europe,  groaning  under  the  rise  of  prices  they  will  no 
longer  cry  to  their  Governments:  "Hang  the  profiteers!" 
but,  "Burn  your  paper  money,  and  go  on  burning  it  till  it 
will  buy  as  much  gold  as  it  used  to  do!" 

2.  Trade  on  a  paper  basis. — If  a  countn^  has  no 
gold,  and  can  therefore  export  none,  can  it  possibly 
engage  in  trade  with  other  countries  ?  The  same  ques- 
tion might  be  asked  with  regard  to  a  country  the  Gov- 
ernment of  wdiich  has  placed  an  embargo  on  the  ex- 
port of  gold.  How,  the  reader  might  reasonably  ask, 
settle  an  adverse  balance  of  trade  ? 

To  answer  this  question  intelligently  the  reader 
must  understand  clearly  the  fundamental  principles 
of  foreign  trade  and  foreign  exchange.  He  must 
perceive  clearly  the  truth  of  these  two  statements : 


£00  INTERNATIONAL  EXCHANGE 

First. — All  foreign  trade  is  essentially  of  the  na- 
ture of  barter,  a  nation's  exports  of  goods  necessarily 
being  equal  in  value  to  its  imports. 

Second. — The  so-called  balance  of  trade,  which  is 
settled  by  a  shipment  of  gold  when  the  trade  is  be- 
tween gold  standard  countries,  is  not  a  real  balance 
and  may  be  wiped  out  by  the  shipment  of  commodi- 
ties other  than  gold. 

Countries  on  a  paper  basis,  not  having  any  gold  or 
not  being  willing  to  ship  any  gold,  settle  or  pay  the  so- 
called  balance  of  trade  by  larger  exports  of  com- 
modities. Essentially  the  foreign  trade  between  a 
country  and  other  countries  is  an  exchange  of  equal 
values  and  these  values  may  be  represented  by  com- 
modities in  general  or  by  gold  and  silver. 

Let  us  suppose  there  is  trade  between  a  country 
on  a  paper  basis  and  one  on  a  gold  basis.  Evidently 
the  exporters  in  the.  gold  countiy  will  not  be  willing 
to  take  their  pay  in  the  money  of  the  paper  country. 
If  then  the  people  of  the  paper  country  import  more 
than  they  export,  how  can  they  possibly  pay  the  bal- 
ance since,  we  will  suppose,  their  country  contains 
no  gold. 

They  will  pay  that  balance  by  an  increased  export 
of  commodities  and  for  this  reason :  Since  the  imports 
in  the  paper  country,  as  we  have  assumed,  have  been 
larger  than  the  exports,  there  will  have  been  a  strong 
demand  for  exchange  on  the  gold  country  and  the 
banks  in  the  paper  countrj^  or  the  dealers  in  exchange 
will  have  raised  their  rates  for  gold  exchange.    These 


IRREDEEMABLE  PAPER  MONEY  201 

higher  rates  of  exchange  will  be  equivalent  to  a  rise 
in  the  prices  of  goods  imported  from  the  gold  comi- 
try  and  therefore  will  tend  to  lessen  the  tide  of  im- 
ports. At  the  same  time  in  the  gold  country  the  price 
of  exchange  on  the  paper  country  will  have  fallen  in 
a  corresponding  degree,  and  hence  have  encouraged 
imports  from  the  paper  country. 

Of  course  a  country  on  a  paper  basis  lacking  a 
supply  of  gold  could  not  conveniently  engage  in  for- 
eign trade  unless  its  bankers  maintain  balances  to 
their  credit  in  gold  standard  countries.  They  create 
and  maintain  these  balances  not  by  shipments  of  gold 
but  by  shipments  of  bills  of  exchange  drawn  by  their 
local  customers  on  the  gold  standard  country.  These 
bills  have  their  origin  of  course  in  the  exports  of  mer- 
chandise from  the  paper  country  to  the  gold  standard 
country. 

The  foregoing  analysis  should  enable  the  reader  to 
understand  why  the  United  States,  a  country  on  the 
gold  basis,  has  been  able  since  the  war  to  carry  on 
an  enormous  foreign  trade  with  the  great  commercial 
nations  of  Europe  which  are  now  upon  a  paper  basis. 
It  should  enable  him  also  to  understand  the  signifi- 
cance of  a  decline  or  of  a  rise  in  the  quotations  of  the 
pound  sterling  and  the  French  franc.  A  decline  of 
sterling  in  the  Xew  York  market,  for  example,  indi- 
cates an  excess  of  exports  from  the  United  States 
whether  of  goods  or  of  securities,  and  at  the  same  time 
it  indicates  a  lower  cost  to  Americans  of  English 
goods  and  securities  thereby  stimulating  an  increase 


202  INTERNATIONAL  EXCHANGE 

of  imports  from  Great  Britain.  A  rise  in  the  New 
York  quotation  of  sterling  exchange  naturally  has  the 
opposite  effect. 

Given  the  characteristics  of  irredeemable  paper 
money  which  have  been  described  it  will  be  readily 
understood  that  no  nation  willingly  puts  its  feet  into 
the  mire  of  fiat  money.  They  are  dragged  into  it 
sometimes  by  mistaken  nations  of  finance,  more  fre- 
quently by  some  national  emergency. 

3.  Fruits  of  war, — Among  the  more  progressive 
nations,  such  currency  is  often  one  of  the  fruits  of 
war.  Thus  the  United  States  lost  the  metallic  basis 
of  its  currency  during  the  Civil  War,  and  Great  Brit- 
ain was  forced  to  a  paper  pound  during  the  Napo- 
leonic struggle  and  in  the  Great  World  War.  The 
significance,  then  of  the  discussion  of  paper  money 
lies  in  the  fact  that  Europe  groans  under  a  paper  cur- 
rency, and  that  most  of  our  trade  is  done  at  the  pres- 
ent time  with  nations  on  a  paper  basis. 

A  few  months  after  the  beginning  of  the  Great 
War,  the  European  demand  for  American  products 
grew  rapidly  and  exports  began  to  outstrip  im- 
ports. Exchange  which  at  the  first  outbreak  of  hos- 
tilities had  risen  to  unapproached  heights,  began  to 
fall  and  sterling  exchange  fell  below  par.  By  the 
issue  of  the  Anglo-French  loan  and  the  extensive 
credits  granted  by  the  American  Government,  Great 
Britain  during  the  war  period  was  enabled  to  hold  the 
rate  at  approximately  $4.75  to  the  pound  sterling. 
It  was  to  her  advantage  to  do  so  both  to  avoid  the  de- 


IRREDEEMABLE   PAPER   MONEY  203 

pressing  moral  effect  of  a  low  rate  of  exchange,  and 
to  make  better  bargains  in  the  purchase  of  goods.  In 
the  language  of  the  day  sterling  exchange  was 
"pegged"  at  $4.75  per  pound,  French  exchange  at 
about  9  per  cent  below  par  and  Italian  exchange  at 
about  18  per  cent  below  par. 

4.  Current  eccchange  rates. — After  the  armistice 
foreign  governments  withdrew  their  support  of  the 
exchange  rates  and  they  fell  rapidly.  Rates  for  Feb- 
ruary 19,  1921,  are  quoted  in  the  following  table: 

Per  cent 

Feb.  19,  Depreciation 

Country                                                              Par  1921  from  Par 

England    $4.8665  $3.8525  20.8 

France     193  .0710  63.2 

Italy 193  .0364  81.1 

Spain    193  .1390  28.0 

Germany 238  .0159  93.3 

Switzerland    193  .1648  14.6 

Sweden    268  .2220  17.2 

Holland 402  .3425  14.8 

Belgimn     193  .0741  61.6 

Argentina 4244  .3511  17.4 

Japan     498  .4838  2.9 

Canada    1.000  .8656  13.4 

The  leading  nations  of  Europe  are  as  shown  by  the 
depreciation  of  their  currency  in  exchange  with  a  gold 
using  country  for  the  time  being  on  a  paper  basis. 
It  is  a  concession  to  national  sensibilities  to  call  their 
present  status  a  suspended  gold  standard.  It  is  a 
concession  which  may  be  most  willingly  made  if  it  im- 
plies that  the  suspension  of  gold  payments  will  soon  be 
removed  by  a  return  to  convertibility  of  the  monetary 
circulation. 


204  INTERNATIONAL  EXCHANGE 

The  difficulties  of  exchange  with  paper  using 
countries  rest  upon  the  absence  of  the  automatic  regu- 
lation of  rate^  which  is  insured  by  the  free  movement 
of  gold,  and  the  more  or  less  violent  fluctuations  in  the 
rates  which  result  from  internal  currency  con- 
ditions. It  is  not  contended  that  paper  money  even 
tho  irredeemable,  may  not  if  carefully  guarded  main- 
tain a  relative  stability  of  value,  and  a  reasonably  even 
course  of  exchange.  But  it  is  to  be  remembered  that 
such  steadiness  if  attained  rests  upon  the  wisdom  of 
governments,  and  is  a  less  certain  reliance  than  the 
automatic  workings  of  the  laws  of  trade. 

The  problems  of  exchange  with  paper  money  coun- 
tries can  perhaps  be  better  explained  by  reference  to 
some  that  have  long  been  on  such  a  basis  than  by  con- 
sidering those  in  which  irredeemable  paper  money  is 
a  recent  affliction,  complicated  by  the  after  effects  of 
a  great  world  struggle. 

5.  Paper  cuiTendes. — The  modern  exponents  of 
paper  money  currency  have  been  chiefly  among  the 
South  and  Central  American  re23ublics.  A  number 
of  these  countries,  altho  they  have  established  a 
theoretical  gold  basis  for  their  currencies,  have  been 
for  a  long  time  embarrassed  by  large  quantities  of  in- 
convertible paper  money.  During  recent  years,  both 
before  and  since  the  Great  War,  strong  efforts  have 
been  made  by  the  more  progressive  of  those  countries 
to  put  their  currencies  and  finances  upon  a  sounder 
basis.  Venezuela,  Uruguay,  Peru,  Ecuador,  Costa 
Rica,  Honduras,  Bolivia  and  Salvador,  have  all  made 


irredee:\lvble  paper  money         205 

progress  towards  this  desired  end.  All  of  these 
countries  are  now  regarded  as  having  Gold  Exchange 
Standards.  Salvador  in  1920  became  an  actual  gold 
standard  country,  her  recent  financial  history  being 
somewhat  similar  to  that  of  Columbia.  Hayti,  which 
formerly  belonged  in  the  theoretical  gold  standard 
group,  is  rapidly  approaching  a  complete  rehabilita- 
tion of  her  currency  system.  The  entry  of  American 
bankers  and  of  American  Government  influence  into 
the  financial  problems  of  that  republic  is  having  a 
salutary  effect. 

6.  Paper  money  as  a  standard. — We  are  not  con- 
cerned in  this  chapter  with  paper  money  as  such,  but 
only  with  paper  currency  which  has  become  a  nation's 
standard  of  value.  Convertible  paper  money  has  per- 
formed a  very  useful  function  in  the  circulation  of 
most  modern  countries.  So  long  as  it  is  freely  con- 
vertible into  gold  on  demand,  its  presence  in  the  cir- 
culation does  not  in  any  way  affect  the  existence  of 
the  gold  standard. 

An  issue  of  paper  monej-  not  supported  by  an 
adequate  gold  reserve,  is  sure  to  prove  a  curse  in  the 
long  run,  as  all  countries  that  have  tried  it  have  found. 
When  a  paper  issue  is  called  upon  to  represent  in  pur- 
chasing power  a  larger  quantity  of  gold  than  that  for 
which  it  will  be  redeemed  in  specie  upon  demand,  it 
at  once  takes  on  the  aspect  of  a  non-interest  bearing 
loan  which  has  been  forced  upon  a  public  by  its  gov- 
ernment. The  natural  consequence  is  that  the  more 
of  it  there  is  issued,  the  less  probability  there  is  of  its 


206  INTERNATIONAL  EXCHANGE 

ultimate  redemption.  Conditions  of  this  sort  always 
produce  depreciation  to  a  dangerous  degree. 

Depreciation  means  that  the  purchasing  power  of 
the  currency  as  compared  with  that  of  gold  has  fallen. 
If  it  requires,  for  instance,  225  paper  dollars  to  pur- 
chase 100  gold  dollars,  gold  is  at  a  premium  of  125 
per  cent  and  paper  money  is  at  44  4-9  per  cent  of  gold 
or  at  a  discount  of  55  5-9  per  cent ;  or  again,  300  per 
cent  premium  means  that  for  100  gold  dollars  one 
would  have  to  give  400  (300  plus  100)  paper  dollars. 

In  this  connection  the  following  problems  will  be 
found  helpful: 

(1)  The  premium  on  gold  is  30%;  at  what  per  cent  dis- 
count is  paper  money? 

c,  1  ,.  300  X  100         30,000       ^^^  J. 

S*^^"^'^'^^  300  plus  100  =  -loo-  =  '^%  ^'^^''""*- 

(2)  Paper  currency  is  at  a  discount  of  75%  as  compared 
with  gold;  what  is  the  premium  on  gold? 

c  1  ^.      .75  X  100       7,500       ^^^^ 

Solution:  — — —  =     '  ,      =  300%  premmm. 

100  —  7o  2o 

7.  Results  of  depreciation, — Following  the  course 
just  outlined,  depreciation  may  proceed  to  an  extent 
that  practically  paralyzes  the  business  of  a  country. 
As  the  process  continues,  all  metallic  money  disap- 
pears from  circulation,  even  tho  there  may  be  a  strong 
tendency  for  minted  coin  from  neighboring  countries 
to  find  its  way  in.  As  depreciation  progresses  all 
goods  offered  for  sale  by  merchants  are  quoted  at  two 
prices,  a  silver  or  gold  price,  and  a  paper  money 
price.     No  more  striking  example  of  the  breakdown 


IRREDEEMABLE   PAPER  MONEY  207 

of  a  paper  currency  has  ever  been  afforded  than  the 
return  to  conditions  of  barter  which  took  place  in 
Austria  during  the  latter  part  of  the  war.  The  fol- 
lowing statement  by  Countess  Szechenyi  gives  a  con- 
crete illustration  of  this  phase : 

"During  Bela  Kun's  reign  of  terror,  which  lasted  from 
March  until  August  .  .  .  men,  formerly  well  off,  to  ob- 
tain food  would  get  together  remnants  of  old  clothes,  per- 
haps an  old  pair  of  shoes,  resoled  for  the  tenth  time,  and 
a  ragged  shirt,  and  walking  out  into  the  country  would  sit 
down  in  the  market  place  of  some  small  town  and  wait  for 
the  peasants  to  come  and  inspect  their  wares.  These  latter 
were  doing  their  best  to  starve  out  the  city  and  to  them 
any  one  from  there  was  a  *dog  of  a  socialist,'  so  they  bar- 
gained to  the  utmost,  and  if  a  man  got  two  eggs  for  two 
shoes,  and  a  spoonful  of  lard  for  a  shirt,  he  was  lucky — 
and  he  had  that  to  take  back  to  his  children." 

The  deliberate  destruction  of  all  currency  values 
in  Russia  may  also  be  cited  as  an  example.  Travel- 
ers from  that  country  reported  late  in  1920  that  a 
very  ordinary  dinner  cost  the  startling  sum  of  eight 
million  rubles  in  paper  money.  It  is  evident  that 
such  money  had  become  nothing  more  than  a  method 
of  counting,  and  bore  little  connection  with  any  stand- 
ard of  value.  Inconvertible  paper  money  has  no  in- 
trinsic value  and  its  gold  value  depends  entirely  upon 
the  amount  of  gold  that  the  public  of  the  country  is 
willing  to  give  for  its  own  paper  unit.  This,  quite  as 
often  as  not,  depends  upon  political  conditions  and 
not  upon  the  factors  of  international  trade. 

8.  Chile. — For  many  years  Chile  has  been  com- 


^08 


INTERNATIONAL  EXCHANGE 


mercially  the  most  important  of  the  paper  standard 
countries.  An  illustration  of  the  vicissitudes  of  a 
country  in  progress  from  a  paper  to  a  gold  exchange 
standard,  the  following  description  of  the  monetary 
system  is  quoted:^ 

Chile's  monetary  system  has  gone  thru  numerous 
vicissitudes  since  the  establishment  of  the  Republic.  It 
must  suffice  to  say  that  since  1898  the  bulk  of  Chile's 
currency  has  consisted  of  inconvertible  paper  money. 
The  Chilean  peso  has  a  gold  content  of  0.5991  gramme  of 
gold,  0.916%  fine,  or  0.54918  gramme  of  pure  gold,  and 
is  worth  at  par  36.5  cents,  or  18  pence  sterling  in  British 
currency,  in  which  it  is  generally  quoted.  The  different 
kinds  of  currency  in  circulation  in  Chile  at  the  end  of 
each  year  from  1912  to  1920  are  shown  in  the  table  below: 

CHILE'S   FIDUCIARY  NOTE  CIRCULATION,  1912-1920 

(In  1,000  pesos.) 
Fiscal  notes 


4^ 

.is 

li 

.2  s 

>     4) 

3 

o 

'2  3 

ji 

<m 

fe  .2 

O  o 

^ 

H  c 

o2 

H  "0 

Dec. 

31, 

1912.. 

.      875 

150,000 

18,482 

169,357 

3 

1,545 

170,904 

Dec. 

31, 

1913.. 

.     873 

150,000 

33,822 

184,696 

3 

1,343 

186,041 

Dec. 

31, 

1914.. 

.      854 

150,000 

45,000 

195,854 

28,136 

990 

224,980 

Dec. 

31, 

1915.. 

.      853 

150,000 

12,054 

162,907 

13,827 

977 

177,712 

Dec. 

31, 

1916.. 

.      853 

150,000 

18,145 

168,998 

8,982 

929 

178,910 

Dec. 

31, 

1917.. 

.      853 

150,000 

24,898 

175,752 

9,482 

928 

186,162 

Dec. 

31, 

1918.. 

.      853 

150,000 

70,588 

221,441 

5,320 

927 

227,688 

Mar. 

17, 

1920.. 

.      853 

150,000 

47,878 

198,741 

28,587 

927 

226,466 

A  small  amount  of  notes  of  ancient  issues  are  in  circula- 
tion, but  the  principal  item  is  150  million  pesos  of  in- 
convertible paper  notes  generally  known  as  the  fixed 
issue.  In  addition  to  this,  there  is  a  conversion  office,  at 
which  certain  authorized  banks  may  obtain  paper  money 

1  Federal  Reserve  Bulletin  for  October,  1920. 


IRREDEEMABLE   PAPER  MONEY  209 

at  the  rate  of  1  peso  for  12  pence  deposited  in  gold,  these 
notes  being  redeemable  on  demand  in  gold.  A  law  in 
1918  authorizes  another  type  of  convertible  notes  at  18 
pence  per  peso,  but  this  being  greatly  in  excess  of  the  ex- 
change value  of  the  peso  no  use  has  been  made  of  this 
provision.  There  is  also  an  issue  of  treasury  notes, 
largely  the  result  of  emergency  legislation  in  1914,  when 
the  Government  issued  notes  to  assist  the  industries, 
chiefly  the  nitrate  industry,  during  the  crisis  caused  by 
the  war.  These  notes  are  supported  by  obligations  of  the 
industries  assisted.  The  amount  outstanding,  which  in 
1914  was  about  28  million,  declined  to  about  5  million  in 
1918,  but  owing  to  the  depression  in  1919  it  increased 
again,  and  in  March,  1920,  stood  at  about  29  million 
pesos.  The  Government  is  also  liable  on  a  small  amount, 
less  than  1  million,  of  notes  issued  by  banks  at  the  time 
when  they  had  circulation  privileges,  siace  taken  over  by 
the  Government.  It  is  generally  considered  that  these 
notes  have  been  lost  or  destroyed  and  that  this  liability 
is  a  nominal  one.  In  the  aggregate,  the  note  circulation 
of  Chile  has  showTi  comparatively  little  growth  during  the 
war  period;  from  225  million  in  1914  it  declined  to  178 
million  in  1915;  then  rose  gradually  to  251  in  1919,  and 
declined  again  to  226  million  by  March,  1920. 

Currency  other  than  the  so-called  fixed  issue  is  largely 
taken  care  of  automatically,  either  by  the  treasury  or  by 
the  conversion  oflace.  In  the  case  of  the  fixed  issue,  there 
has  been  a  fund  accumulated  in  gold  that  is  sufficient  to 
effect  conversion.  This  fund  was  built  up  largely  under 
the  operation  of  a  law  of  1909  by  which  not  less  than  one- 
half  million  pesos  per  month  were  deposited  in  the  treas- 
ury or  in  specified  banks  abroad  out  of  receipts  from  the 
gold  export  duties.  In  1914  this  fund  amounted  to  108 
million  pesos  at  18  pence  per  peso;  on  October  31,  1919, 
the  latest  date  for  which  figures  are  available,  the  fund 
was  about  113  million  pesos.  A  table  showing  the  distri- 
bution of  this  fund  is  attached.  It  will  be  noted  that  in 
1914  the  larger  part  of  it — 74  million — was  in  England, 

XVIII — 15 


210 


INTERNATIONAL  EXCHANGE 


and  30  million  was  in  Germany.  The  gold  was  trans- 
ferred from  Germany  to  Chile  thru  the  sale  by  Germany 
of  part  of  her  stock  of  nitrates  to  America;  that  is,  the 
Germans  paid  off  their  gold  debt  to  Chile  by  transferring 
nitrates  to  Americans,  and  the  Americans  sold  the  nitrates 
to  the  Allies  for  gold,  which  was  ultimately  shipped  to 
Chile. 

CHILE'S  GOLD  CONVERSION  FUND,  1910-1919 
(In  1,000  pesos  gold  at  18  d.) 


Year 
1910 
1911 
1912 
1913 
1914 
1915 
1916 
1917 
1918 


In 

the 
treasury 


IN  FOREIGN  BANKS 


3,644 

3,644 

3,644 

24,765 

64,146 


England 

9,123 

9,442 

9,773 

10,115 

74,261 

80,263 

58,766 

54,748 

47,054 


Germany 
85,360 
88,577 
91,915 
95,379 
30,256 
27,128 
22,226 
2,721 
62 


United 

States 


Oct.  31,  1919.      66,667         45,788 


3,125 

11,911 

10 

10 


Total 

94,483 

98,019 

101,688 

105,494 

104,517 

107,391 

84,116 

69,380 

47,126 

45,798 


Total 


94,4a3 

98,019 

101,688 

105,494 

108,161 

111,034. 

87,760 

94,145 

111,272 

1  112,610 


Since  the  cessation  of  hostilities  a  considerable  portion 
of  the  gold  has  been  returned  to  Chile  and  at  the  present 
time  the  bulk  of  it  is  in  the  treasury,  and  nearly  all  the 
remainder  in  England.  It  should  be  noted  that  at  every 
date  shown  in  the  table  the  conversion  fund  was  suffi- 
cient to  redeem  the  inconvertible  notes  at  12  pence  per 
peso,  which  was  considered  a  fair  figure  in  view  of  the 
prevailing  rate  of  exchange,  and  to  leave  a  balance  to  the 
credit  of  the  treasury.  On  October  31,  1919,  for  instance, 
there  were  112,610,000  pesos  at  18  pence  per  peso  in  the 
conversion  fund.  This  amount  would  redeem  168,916,000 
pesos  at  12  pence  per  peso,  i.  e.,  it  would  redeem  the 
outstanding  150  millions,  and  leave  a  balance  of  about  19 
million  pesos .  The  fact  that  redemption  was  not  effected 
is   traceable   to   an   economic   and  political   controversy 

1  Including  145  thousand  pesos  classed  as  miscellaneous. 


IRREDEEMABLE  PAPER  MONEY  211 

which  has  been  waged  in  Chile  for  more  than  a  genera- 
tion. ...  In  1909  there  was  an  agitation  for  conversion, 
but  the  ParHament  instead  passed  a  bill  establishing  the 
foreign  conversion  fund,  a  measure  which  was  vetoed  by 
the  President  and  passed  over  his  veto.  Conversion  has 
constantly  been  postponed,  the  latest  postponem_ent 
being  for  six  months  after  July  of  the  current  year  (1920). 
As  a  consequence  of  the  instability  of  the  exchange 
rate  and  of  the  value  of  the  paper  currency,  it  is  not  un- 
common in  Chile  to  make  bank  deposits  in  terms  of  pounds 
sterling  and  more  recently  of  dollars  and  to  issue  checks 
against  them,  so  that  there  is  a  considerable  circulation 
of  bank  credit  expressed  in  foreign  currencies . 

REVIEW 

Describe  rise  of  irredeemable  paper  money  in  Europe. 
How  is  trade  carried  on  with  paper  using  countries  } 
What  is  the  present  status  of  exchange  with  leading  nations  ?" 
Describe  effect  upon  values  of  an  over-issue  of  paper. 
Summarize  exchange  conditions  with  Chile. 


CHAPTER  XIII 

NEW  YORK  AND  LONDON  AS  FINANCIAL  CENTERS 

1.  New  York's  prominence  in  world  finance, — The 
Great  War  in  Europe,  besides  making  the  United 
States  a  creditor  nation,  threw  upon  New  York 
City,  its  financial  centre,  a  great  burden  of  financial 
responsibihty  and  gave  rise  to  the  behef  in  many 
quarters  that  New  York  City  was  destined  to  be 
henceforth  the  world's  financial  centre.  For  sev- 
eral centuries  before  the  war,  London  had  admitted- 
ly been  the  centre  of  the  world's  financial  operations. 
Is  it  possible  that  New  York  in  the  near  future,  be- 
cause of  the  advantage  given  her  by  the  war,  may 
wrest  the  title  from  London  and  hold  it  for  centuries 
to  come? 

2.  What  makes  a  financial  centre, — Many  circum- 
stances have  combined  in  the  past  to  give  London  its 
supremacy  in  finance.  Its  geographical  position  mid- 
way between  the  eastern  and  western  markets,  its 
exports  and  imports  carried  in  EngHsh  bottoms  to 
and  from  all  the  world's  ports,  its  sound  monetary 
system,  a  sterling  bill  for  a  century  having  been  re- 
garded as  the  equivalent  of  gold,  its  liquid  discount 
market,  its  relatively  low  and  stable  rate  of  interest, 
its  large  investments  in  foreign  countries  and  the  high 
reputation  for  business  honor  and  square  dealing  en- 

212 


FINANCIAL   CENTERS  213 

joyed  b}^  English  bankers  and  traders  thruout  the 
world,  were  among  the  most  important  circumstances 
that  contributed  to  the  making  of  the  sterling  bill 
practically  equivalent  to  a  world  medium  of  exchange. 

Of  the  circumstances  mentioned  in  the  foregoing 
paragraph  at  least  three  are  absolutely  essential. 

First. — No  city  can  become  or  long  remain  the 
world's  financial  centre  unless  it  is  in  close  commercial 
touch  with  practically  all  the  nations  of  the  earth. 

Second. — Its  monetary  system  must  be  firmly  es- 
tablished on  the  gold  basis  and  offer  the  world  a  free 
gold  market. 

Third. — It  must  have  a  liquid  discount  market. 

Any  city  possessing  these  conditions  will  always 
be  a  dangerous  rival  of  London  even  tho  the  latter 
city  as  the  years  go  on  regains  the  supremacy  lost 
during  the  war. 

And  any  city  possessing  these  fundamental  advan- 
tages will,  as  it  gradually  acquires  leadership  in  world 
finance,  at  the  same  time  acquire  the  diversified  and 
freer  banking  system,  the  high  credit  standing  w^ith 
foreign  nations,  numerous  branches  in  foreign  coun- 
tries, and  the  large  mercantile  marine  for  which  Eng- 
land has  been  noted  in  recent  centuries. 

3.  Finance  follows  trade. — The  old  saying  that 
trade  follows  the  flag  does  not  express  so  important 
a  truth  as  the  statement  that  finance  follows  trade. 
New  York  is  the  financial  centre  of  the  United  States 
and  Canada  because  it  trades  directly  or  indirectly 
with  all  the  merchants  of  these  two  countries.     In 


214  INTERNATIONAL  EXCHANGE 

every  community  of  the  United  States  and  in  most 
of  the  towns  and  cities  of  Canada  will  be  found  men 
who  have  bought  goods  from  New  York  or  who  are 
shipping  commodities  to  New  York.  Those  who  are 
shipping  to  New  York  receive  New  York  exchange 
in  payment  and  sell  it  to  their  bank.  Those  who  pur- 
chase goods  or  securities  from  New  York  buy  New 
York  exchange  from  their  local  bank  and  send  it  to 
their  New  York  creditor.  As  has  been  already  ex- 
plained in  earlier  chapters  of  this  book,  New  York 
exchange,  because  of  New  York's  commanding  posi- 
tion as  a  trade  centre,  has  long  been  the  financial 
center  of  the  country.  The  powerful  banks  in  New 
York  did  not  make  it  the  financial  center.  On  the 
contrary,  they  are  themselves  the  natural  and  neces- 
sary or  inevitable  products  of  New  York  City's  enor- 
mous trade  with  the  interior. 

In  a  similar  way  and  for  similar  reasons  London 
became  the  world's  financial  center.  England's  in- 
sular position  with  a  territory  able  to  support  only  a 
comparatively  small  population  compelled  her  cen- 
turies ago  to  become  the  world's  workshop,  importing 
raw  materials  from  all  quarters  of  the  globe  and  ex- 
porting them  in  a  great  variety  of  manufactured 
articles,  most  of  them  famous  for  their  honest  work- 
manship. Her  business  leaders  encouraged  the  build- 
ing of  ships  because  they  wanted  proper  markets  for 
English  wares,  and  freedom  of  trade,  first  advocated 
by  Adam  Smith  in  1776,  was  adopted  by  England 
early  in  the  last  century  because  it  was  recognized 


FINANCIAL  CENTERS  215 

that  exports  and  imports  must  increase  together  and 
that  taxes  on  imported  raw  materials  increased  the 
EngHsh  manufacturer's  cost  and  tended  to  place  him 
at  a  disadvantage  with  foreign  competitors. 

It  is  doubtless  true  that  England  might  not  have 
gained  her  enormous  world  trade  and  her  financial 
leadership  had  she  not  in  the  beginning  encouraged 
shipbuilding  and  sent  her  flag  into  the  harbors  of  all 
the  seas.  Yet  the  essential  cause  of  her  leadership  in 
finance  was  her  world  trade  and  not  her  great  mer- 
chant fleet. 

4.  World  exchange  must  mean  gold. — It  is  com- 
mon knowledge  that  people  are  perfectly  willing  to 
accept  paper  money  or  checks  and  drafts  in  payment 
for  the  goods  they  sell,  provided  they  are  quite  con- 
fident that  this  paper  can  be  exchanged  for  gold  if 
desired,  and  so  long  as  such  confidence  prevails  no- 
body thinks  of  asking  for  the  gold.  But  nobody 
wants  anything  to  do  with  a  promise  to  pay  which 
is  tainted  with  uncertainty.  Such  paper  can  get  into 
circulation  only  at  a  discount. 

So  no  city  can  become  a  world  leader  in  finance 
unless  merchants  and  bankers  are  everywhere  con- 
vinced that  drafts  on  that  city  will  be  promptly  met 
and  paid  in  gold.  If  thruout  the  world  there  is  dis- 
trust of  its  monetary  or  banking  system,  it  cannot  be- 
come a  world  financial  centre  no  matter  how  great  its 
exports  and  imports.  England  before  the  war  had 
long  been  on  the  gold  basis  and  London  had  long  been 
the  world's  freest  gold  market.     Sterling  bills  of  ex- 


216  INTERNATIONAL  EXCHANGE 

change  were  bought  and  sold  in  the  United  States, 
in  China,  in  South  America  and  in  all  other  countries 
where  trade  had  risen  above  the  level  of  barter,  and 
every  buyer  had  absolute  confidence  that  his  bills 
could  instanth^  be  exchanged  in  London  for  gold,  or 
be  used  for  the  payment  of  debts  in  London  quite  as 
effectively  as  gold  itself.  The  War  however  threw 
England  off  the  gold  basis  just  as  did  the  Napoleonic 
Wars  over  one  hundred  years  ago  and  London  im- 
mediately lost  its  world's  supremacy  in  finance. 

5.  Liquid  discount  7narket. — The  reader  will  have 
learned  from  the  volume  on  "Banking"  that  it  is  prac- 
tically impossible  for  a  country  to  possess  a  discount 
market  unless  its  financial  operations  are  stabilized 
and  supported  by  one  or  more  very  powerful  banking 
institutions,  and  that  in  most  of  the  countries  of 
Europe  such  markets  have  been  built  up  because  of 
the  existence  of  large  central  banks,  many  of  them 
government  owned  or  controlled.  The  Bank  of  Eng- 
land, established  in  1694,  is  privately  owned  and  con- 
trolled, but  it  enjoys  certain  exclusive  privileges 
which  compel  it  in  self  defense  to  assume  all  the  re- 
sponsibilities of  a  government  bank,  so  that  within 
certain  limits  it  has  become  a  regulator  of  the  London 
money  market  and  a  source  of  relief  to  London  banks 
in  times  of  stress.  Hence  London  before  the  War 
had  developed  the  most  sensitive  and  liquid  discount 
market  in  the  world.  Bills  and  securities  of  all  kinds 
found  in  London  a  readier  market  than  in  any  other 
city.    It  was  the  world's  market  for  capital.    In  that 


FINANCIAL  CENTERS  217 

city  one  found  the  greatest  lenders  and  the  biggest 
borrowers.  To  convert  a  bill  of  exchange  into  gold 
was  as  easy  as  it  is  to  cash  a  check  in  an  American 
bank. 

6.  New  York's  advantages, — It  is  clear  that  Lon- 
don has  lost  for  a  time  its  commanding  position  in 
finance,  for  a  sterling  bill  and  paper  pound  no  longer 
mean  a  definite  quantity  of  gold.  During  and  since 
the  war  the  gold  value  of  the  paper  pound  has  fluc- 
tuated so  rapidly  and  violently  that  few  people  have 
any  idea  what  the  quotation  will  be  tomorrow,  to  say 
nothing  of  next  week.  For  example  in  the  year  1920 
sterling  exchange  varied  from  $3.19  to  $4.06  2/3  and 
in  the  tw^o  months  of  January  and  February,  1921, 
between  $3,531/4  and  $3.92.  So  long  as  there  is  pos- 
sibility of  such  fluctuations  in  the  future,  or  to  be 
more  exact,  so  long  as  the  paper  pound  is  not  redeem- 
able easily  and  promptly  in  gold  of  the  prescribed 
w^eight  and  fineness,  it  is  certain  that  London  cannot 
regain  its  supremacy  and  that  Xew  York  will  keep 
the  leadership  in  finance. 

New  York  now  possesses  two  of  the  conditions  es- 
sential to  leadership,  namely,  a  sound  monetary  sys- 
tem on  the  gold  basis  together  with  a  free  gold 
market,  and  a  federal  banking  system  that  is  rapidly 
developing  a  liquid  discount  market.  Unhappily  the 
foreign  trade  of  the  L^nited  States  in  the  past  has 
not  only  been  carried  in  foreign  ships  but  has  not  had 
a  world  wide  distribution.  The  bulk  of  our  exports 
before  the  war  went  to  Europe,  and  some  of  our 


218  INTERNATIONAL  EXCHANGE 

exporters  were  not  ahvays  conscientious  in  their 
efforts  to  have  their  goods  correspond  honestly  with 
specifications  and  promises.  Furthermore,  during  the 
last  century  we  indulged  in  some  financial  and  mone- 
tary experiments  which  made  many  foreigners  sus- 
picious of  our  financial  sanity.  For  these  reasons  in 
some  of  the  world's  market  places  and  banking  circles 
"dollar  exchange,"  as  drafts  on  Xew  York  are  called, 
are  looked  upon  rather  dubiously.  If  New  York 
is  to  hold  its  newly  acquired  leadership,  no  effort  must 
be  spared  to  win  foreigners'  confidence  in  America's 
determination  to  maintain  the  gold  standard,  in  the 
honesty  of  American  manufacturers,  in  the  funda- 
mental soundness  of  our  banking  system  and  in  the 
absolute  freedom  of  our  gold  market.  Even  then  New 
York  may  lose  out  in  the  race  with  London  as  soon 
as  England  gets  back  on  the  gold  basis,  if  unwise  leg- 
islation hampers  the  growth  of  American  shipping,  or 
if  high  tariffs  raise  the  costs  of  American  products 
and  arouse  resentment  in  the  bosoms  of  our  best  cuS" 
tomers. 

As  a  creditor  nation  the  United  States  must  in 
the  not  far  distant  future  become  a  heavy  importer  of 
foreign  made  goods.  To  many  Americans  this  pros- 
pect is  not  pleasing,  and  there  is  little  doubt  that  it 
will  be  the  subject  of  much  debate  during  the  coming 
years.  In  this  connection  we  can  be  certain  about  one 
thing,  namely,  that  New  York  City  cannot  long  re- 


FINANCIAL  CENTERS  219 

main  a  world  center  in  finance  if  ships  laden  with  the 
world's  goods  do  not  find  a  welcome  off  Sandy  Hook.i 
7.  Physical  conditions  favorable  to  London. — ■ 
London  is  situated  on  the  threshold  of  Europe  in 
the  heart  of  the  world's  commercial  activities,  direct- 
ly opposite  the  estuary  of  the  Scheldt  and  nearly 
opposite  that  of  the  Rhine,  and  is  within  a  short  dis- 
tance of  every  important  exchange  center  in  the  world 
with  the  exception  of  Xew  York.  This  may  be  con- 
sidered as  an  almost  insuperable  obstacle  to  Xew 
York's  ambition. 

London  has  the  advantage  of  water  lanes  free  from 
ice  and  fog  to  every  large  port  in  the  world  with  the 
exception  of  Xew  York;  the  chmate  is  equable  and 
liquids  and  perishable  goods  run  little  or  no  danger 
of  freezing  in  winter. 

The  restricted  insular  area  of  Great  Britain,  a 
little  larger  than  the  State  of  Minnesota,  is  also  an 
important  factor,  as  it  not  only  affords  an  immense 
seaboard  compared  with  its  size,  but  concentrates  the 
population.  A  frequent  and  rapid  transit  service 
makes  Great  Britain  practically  one  large  city  with 
London  as  the  business  center.  Every  bank  in  the 
country  has  a  branch  or  correspondent  in  London, 
carries  its  reserves  there  and  clears  direct  with  every 
part  of  the  country  thru  its  London  agent.  The  econ- 
omy of  resources  effected  by  this  natural  concentra- 

I  The  remainder  of  the  present  chapter  is  taken  by  permission  from  an 
article  by  Mr.  E.  L.  Stewart  Patterson,  published  in  the  Annals  of  the 
American  Academy  of  Political  and  Social  Science,  November,  1916. 


220  INTERNATIONAL  EXCHANGE 

tion  of  funds  is  seldom  realized  and  is  worthy  of  study. 
The  insular  position  of  London  renders  it  compara- 
tively free  from  the  danger  of  invasion  and  seizure  by 
a  hostile  power  and  this  immunity  has  been  a  factor 
in  making  London  a  world  depository. 

8.  Mail  and  cable  facilities, — The  geographical  sit- 
uation of  Great  Britain,  coupled  with  her  willingness 
to  invest  money  in  international  utilities,  has  placed 
her  in  a  unique  position  as  regards  mail  and  cable 
facilities.  Thru  her  immense  mercantile  navy,  Lon- 
don has  direct  communication  by  fast  steamers  with 
every  important  port  in  the  world  and  consequently 
aicts  as  a  foreign  mail  clearing  house  for  all  other 
countries.  If  French,  German  or  Dutch  steamers 
afford  a  faster  service  to  any  point  they  can  be  util- 
ized with  little  or  no  loss  of  time. 

As  Great  Britain  owns  and  operates  two-thirds  of 
the  submarine  cable  mileage  of  the  world,  it  is  natural 
that  London  should  be  a  great  cable  center  with  prac- 
tically direct  communication  the  world  over.  This 
service  is  now  supplemented  by  a  far  flung  system 
of  wireless  stations.  Furthermore,  under  normal 
conditions,  every  main  railroad  on  the  continent  of 
Europe  gives  its  best  service  and  equipment  to  its 
London  mail  train.  The  Trans-Siberian  Railway 
already  gives  access  by  rail  to  the  Pacific  and  it 
is  only  a  question  of  time  before  thru  connections 
with  India,  China  and  South  Africa  will  be  estab- 
lished. 

9.  Time  advantages, — In  dealing  in  foreign  ex- 


FINANCIAL   CENTERS  221 

change  and  stocks  London  is  the  center  of  the  world 
as  regards  time.  She  knows  the  conditions  in  eastern 
markets  before  they  close  and  is  open  long  enough 
to  operate  in  New  York  before  her  own  markets  close. 
Her  position  is  therefore  pivotal  as  regards  time  and 
distance.  Time  is  the  essence  of  an  exchange  trans- 
action; a  day's  delay  may  turn  a  profit  into  a  loss  and, 
granting  that  New  York  lias  the  means  and  enter- 
prise to  create  an  efficient  steamship  and  cable  service 
in  due  course,  how  can  she  eliminate  the  more  serious 
handicap  of  distance  by  water  from  all  other  financial 
centers  ? 

10.  National  characteristics. — Great  Britain  is  a 
land  of  slowly  acquired  fortunes,  and  the  banker  and 
merchant  there  are  content  with  small  profits  and 
slow  returns.  They  have  long  realized  the  fact  that 
trade  follows  the  loan  and  have,  therefore,  been  will- 
ing to  invest  money  in  foreign  countries  with  no  pros- 
pect of  recovering  immediate  returns  or  large  profits. 
The  financing  of  these  loans  abroad  has  been  an  im- 
portant factor  in  making  the  London  money  market 
so  supreme.  It  is  doubtful  if  the  American  is 
adapted  temperamentally  for  operations  of  this  kind 
or  for  the  small  profits  of  the  exchange  operations 
connected  therewith.  The  United  States  has  still  a 
vast  area  in  proportion  to  its  population,  its  natural 
resources  are  not  yet  fully  developed  and  it  is  a  coun- 
try of  large  and  rapidly  acquired  fortunes.  It  will, 
therefore,  be  many  years  before  the  investors  and  en- 
trepreneurs are  forced  to  direct  their  attention  to  for- 


222  INTERNATIONAL  EXCHANGE 

eign  fields.  Great  Britain,  before  the  war,  invested 
over  a  billion  dollars  annually  in  foreign  enterprises 
and  at  the  beginning  of  the  war  had  between  twenty 
and  thirty  billions  so  invested.  The  United  States 
at  that  time  was  a  debtor  nation  for  over  six  billion 
dollars,  this  amount  was  largely  paid  off  or  absorbed 
during  the  war,  she  had  to  invest  nearly  twenty-five 
billions  before  she  could  be  on  an  equal  footing  with 
Great  Britain  in  this  connection. 

11.  Willingness  to  seek  fortune  abroad. — The  aver- 
age family  of  Great  Britain  is  large  compared  with 
that  of  the  United  States  and  there  is  little  room  and 
few  opportunities  at  home  for  the  younger  sons. 
This  class  of  men  finds  its  way  into  the  army,  the  navy 
and  the  mercantile  marine  and  go  abroad  as  clerks, 
etc.,  to  foreign  and  colonial  banks  and  commercial 
houses.  The  more  venturesome,  as  soon  as  they  ac- 
quire experience,  carry  British  trade  and  prestige  to 
new  and  undeveloped  countries — British  subjects  are 
found  everywhere,  no  matter  how  remote  the  place. 

The  young  American,  on  the  other  hand,  has  so 
many  opportunities  at  home  that  there  is  little  in- 
ducement to  venture  abroad  except  for  pleasure. 
He  is  probably  the  only  son  of  the  family  and  takes 
up  his  father's  business  or  is  assisted  in  setting  up  in 
business  for  himself.  If  he  goes  abroad,  he  is  not 
content  with  a  subordinate  position,  but  wants  to  be 
his  own  master  and  strike  out  for  himself.  Prefer- 
ably he  goes  back  to  his  home  to  do  this.  We  might 
instance  the  experience  of  the  International  Banking 


FIXAXCIAL   CENTERS  223 

Corporation,  a  state  bank,  chartered  in  Connecticut 
with  foreign  branches  chiefly  in  the  Oriento  This 
bank,  tho  an  American  institution,  is  manned  prin- 
cipally by  Englishmen.  It  will  be  interesting  to 
watch  the  personnel  of  the  staff  of  foreign  branches  of 
national  banks  established  under  the  Federal  Reserve 
Act. 

12.  LondoJis  discount  market, — The  natural  com- 
plement of  a  free  gold  market  is  a  liquid  money  mar- 
ket capable  of  absorbing  bills  of  exchange  to  an  al- 
most unlimited  amount.  This  unique  feature  of  the 
London  market  makes  a  first-class  bill  of  exchange 
on  London  as  acceptable  as  gold.  The  strength  and 
broadness  of  the  London  market,  apart  from  the  nat- 
ural resources  of  the  country,  lie  in  the  ebb  and  flow 
of  foreign  capital  thru  the  machinery  of  the  branches 
of  foreign  and  colonial  banks  established  there. 

Altho  London  does  not  particularly  encourage  the 
establishment  of  foreign  banks,  it,  on  the  other  hand, 
does  nothing  to  restrict  the  movement  and  allows  free- 
dom in  banking  privileges  to  all  comers  of  good  stand- 
ing. This  broad  minded  policy,  tho  it  perhaps  affects 
to  a  certain  extent  the  individual  interests  of  some  of 
the  British  banks,  is  recognized  as  of  great  importance 
to  London  and  the  country  in  general,  and  therefore 
indirectly  to  the  banks  themselves.  These  branches 
of  foreign  banks,  with  their  network  of  correspond- 
ents thruout  the  world,  in  addition  to  their  direct  in- 
fluence on  the  exchange  situation,  give  invaluable  as- 


224  INTERNATIONAL  EXCHANGE 

sistance  to  the  Bank  of  England  in  preserving  the 
equilibrium  of  the  money  market. 

The  policy  of  New  York  in  connection  with  foreign 
banks  is  just  the  reverse  of  that  of  London  and  is  ap- 
parently based  on  a  local  and  narrow  point  of  view. 
New  York  bankers  have  always  discouraged  the  es- 
tablishment of  foreign  banks  in  their  midst  and  have 
evoked  state  legislation  and  other  means  to  this  end. 
A  few  foreign  banks  are  represented  by  agents,  not 
by  branches.  They  cannot  take  deposits  or  discount 
commercial  paper  and  their  activities  are  practically 
restricted  to  making  call  loans  and  dealing  in  foreign 
exchange. 

The  London  discount  rates  are  controlled  by  a  cen- 
tral institution,  the  Bank  of  England,  and  changes  in 
the  rate  are  not  only  infrequent  but  seldom  rise  above 
six  per  cent.  By  this  control  of  the  money  market 
thru  the  bank  rate,  as  it  is  called,  the  Bank  of  Eng- 
land has  been  able  to  attract  gold  to  London  by  rais- 
ing the  rate  whenever  the  exigencies  of  commerce  and 
the  exchange  situation  require  it. 

REVIEW 

What  is  meant  by  a  financial  center  ? 

Why  is  New  York  the  financial  center  of  the  United  States.^ 

What  are  present  advantages  of  New  York  in  world  finance? 

What  conditions  gave  London  its  supremacy?  Distinguish  be- 
tween those  which  are  permanent  and  those  which  resulted  from: 
historical  development. 


CHAPTER  XIV 

RESTORATION  PROSPECTS  FOR  EXCHANGE 

1.  Easting  conditions. — The  frequent  references 
to  normal  conditions  made  in  this  volume  may  give 
rise  in  the  reader's  mind  to  some  question  regarding 
the  abnormal  state  of  affairs  that  has  been  with  us 
since  the  signing  of  the  armistice  in  1918.  The  treat- 
ment of  the  subject  of  foreign  exchange  cannot  enter 
either  into  a  history  of  war  finance  methods,  or  the 
interaction  of  the  economic  forces  that  has  brought 
about  the  conditions  of  the  reconstiniction  period.  The 
evidences  of  severe  economic  disturbance  have  been 
apparent  to  all.  High  prices  and  speculation  of  the 
most  undesirable  kind,  strikes  and  lockouts,  em- 
bargoes and  restrictions  both  in  commerce  and  finance, 
scarcity  of  raw  materials,  even  of  the  necessaries  of 
life,  up  to  the  starvation  point  in  some  countries,  while 
others  held  unsalable  surplus  stocks  of  these  goods; 
these  have  been  a  few  of  the  worst  symptoms  of  the 
disease  from  which  world  commerce  has  been  suffer- 
ing. 

Historians  of  war  epochs  have  often  expressed  sur- 
prise at  the  recuperative  power  displayed  by  devas- 
tated nations.  Greater  thrift,  more  willingness  to 
work,  the  restoration  of  gainful  trade,  the  introduc- 
tion of  more  efficient  methods  and  high  patriotic  ideals 

xviii— 16  225 


226  INTERNATIONAL  EXCHANGE 

applied  to  the  payment  of  war  debts,  have  never  be- 
fore failed  within  a  few  years  to  rehabilitate  on  an 
even  more  prosperous  footing  the  broken  commercial 
life  of  nations.  In  the  present  juncture  there  was 
perhaps  too  great  a  reliance  upon  the  immediate 
effect  of  such  recuperative  forces.  During  the  last 
quarter  of  1920  the  condition  of  the  various  for/sign 
exchanges  reflected  a  state  of  affairs  that  showed  less 
improvement  during  the  previous  eventful  two  years 
than  even  the  most  pessimistic  expectations  had  fore- 
casted. 

All  regular  exchange  operations  with  a  number  of 
countries  such  as  Finland,  Roumania  and  some  of  the 
new  states  of  Central  Europe,  had  practically  disap- 
peared in  so  far  as  Xew  York  was  concerned.  Lon- 
don was  trying  to  find  some  basis  other  than  that  of 
barter,  pure  and  simple,  upon  which  to  establish  busi- 
ness relations  with  such  countries  and  was  meeting 
with  only  slight  success.  Sterling^  and  franc  ex- 
change in  Xew  York  had  gone  down  to  startlingly 
low  levels.  The  Italian  and  Greek  exchanges  reached 
so  low  an  ebb  that  trade  with  those  countries  was  al- 
most paralyzed.  The  currencies  of  the  former  cen- 
tral empires  were  quoted  at  less  than  a  tenth  of  their 
pre-war  prices.  Russian  exchange  was  non-existent 
and  all  the  countries  that  were  neutral  during  the  war 
saw  the  rates  both  in  London  and  New  York  go 
steadily  against  them. 

It  must  be  borne  in  mind  that  owing  to  the  opera- 
tion of  other  forces,  the  exchanges  failed  to  reflect 


RESTORATION   PROSPECTS  227 

the  progress  in  world  reconstruction  that  had  been 
made  up  to  the  end  of  1920.  Industrially,  Belgium 
had  in  the  first  two  years  of  peace  returned  to  about 
eighty  per  cent  of  her  former  productivity.  Both  in 
•agriculture  and  industry  France  had  shown  splendid 
progress  toward  a  new  normal  adjustment.  In  Great 
Britain  the  factories  had  almost  all  got  back  to  peace- 
time conditions  and  British  exports  were  increasing 
rapidly.  Italy,  after  a  period  of  strenuous  readjust- 
ment between  capital  and  labor  was  settling  down  to 
steady  production,  and  Germany  was  working  up  all 
the  raw  material  she  could  produce  or  obtain  from 
the  outside  world. 

2.  The  position  of  New  York  and  of  London. — Dur- 
ing this  period  Xew  York  has  played  the  new  role  of 
world  creditor,  and  in  a  limited  way  that  of  world 
banker.  During  the  stress  and  strain  of  war  the  cap- 
ital accumulations  of  the  United  States  were  absorbed 
by  her  war  needs  and  in  lending  aid  and  comfort  to 
her  allies.  While  this  was  going  on  new  enterprises 
at  home  not  connected  with  war  activities  lagged,  and 
in  the  months  since  the  armistice  have  made  heavy 
demands  upon  the  capital  market.  Foreign  nations, 
municipalities  and  productive  enterprises  have  had 
to  compete  in  the  Xew  York  market  with  this  local 
demand.  Yet  the  number  of  foreign  securities  listed 
on  the  New  York  Exchange  continues  to  grow.  With 
every  disposition  on  the  part  of  American  capital  to 
lend  assistance  to  our  recent  allies  in  the  work  of 
rehabilitation  it  has  been  difficult  for  them  to  find 


228  INTERNATIONAL  EXCHANGE 

adequate  security  as  a  basis  for  credit.  The  exchanges 
have  favored  Xew  York  and  this  under  normal  condi- 
tions would  have  led  to  the  export  of  goods  and  capi- 
tal. But  the  exchange  market  lacks  the  automatic  ad- 
justment which  arises  from  the  free  movement  of 
gold,  and  since  the  exchanges  depend  in  so  large 
measure  upon  the  depreciation  of  currency  it  is  diffi- 
cult to  measure  their  exact  significance. 

London  has  occupied  the  unenviable  position  of 
being  a  debtor  to  Xew  York  and  a  creditor  to  all 
Europe  and  much  of  the  rest  of  the  world.  Sterling  has 
hovered  between  $3.45  and  $3.75  in  Xew  York  while 
at  a  premium  on  the  continent  of  Europe.  Great 
Britain  has  had  to  pay  at  an  unfavorable  rate  of  ex- 
change for  such  articles  of  prime  importance  as  wheat 
and  cotton,  and  at  the  same  time  the  rates  from  her 
best  customer  countries  have  been  so  unfavorable  to 
them  that  the  export  of  goods  manufactured  in  the 
British  Isles  has  been  greatly  hampered.  All  the 
former  belligerent  countries  of  Europe  are  deeply  in 
debt  to  Great  Britain.  In  London  there  has  been 
real  striving  to  find  a  basis  for  still  further  credits  to 
the  distressed  nations.  In  the  United  States  sincere 
effort  has  been  made  to  accomplish  the  same  purpose, 
notably  the  revival  in  1920  of  the  War  Finance  Board 
and  the  creation  by  bankers  and  business  men  of  the 
International  Finance  Corporation  with  a  capital  of 
$100,000,000. 

These  conditions  have  militated  strongly  against 
Britain's  full  recovery  of  her  pre-war  position  and 


RESTORATION   PROSPECTS  229 

have  prevented  the  estabhshment  of  an  equihbrium 
of  exchange  at  the  place  where  it  is  most  vital  to  the 
well-being  of  the  world's  commerce.  Financiers  in 
Britain  realized  at  an  early  date  the  necessity  of  ex- 
tending all  possible  credit  and  other  assistance  to 
Europe.  To  accomplish  this  end  they  have  stood  as 
intermediaries  between  the  United  States  and  con- 
tinental borrowers  and  have  assumed  on  this  semi- 
altruistic  basis  a  vast  responsibility  that  has  played 
a  paxdominant  part  in  delaying  the  return  of  sterling 
to  a  more  normal  rate  of  exchange. 

3.  Reasons  for  disorganization, — There  are  four 
clearly  defined  reasons  for  the  disorganization  of  for- 
eign exchange.  Briefly  stated  they  are:  1.  The  war 
period  of  one  sided  business;  2.  The  existence  of 
paper  currencies  unsupported  by  adequate  gold  re- 
serves; 3.  Loss  of  means  of  production;  4.  Disor- 
ganization of  working  forces. 

A  full  consideration  of  the  relations  of  these  rea- 
sons to  one  another,  and  the  extent  to  which  any  one 
may  be  directly  or  indirectly  responsible  for  the  exist- 
ence of  another  would  lead  us  into  the  realm  of  eco- 
nomics, rather  than  that  of  exchange.  We  shall, 
therefore,  consider  each  of  the  reasons  in  its  effect 
upon  international  exchange  only. 

4.  Spending  more  than  national  income. — No  busi- 
ness, whether  individual  or  national,  can  continue  to 
buy  indefinitely  while  making  no  profit  producing 
sales.  To  do  so  means  bankruptcy.  Yet  during  the 
years  of  the  war  the  belligerent  nations  of  Europe 


230  INTERNATIONAL  EXCHANGE 

were  forced  to  follow  this  course  at  breakneck  speed. 
The  result  was  to  use  up  what  may  be  termed  their 
quick  assets  in  varying  degrees  that  range  all  the 
way  from  the  seemingly  complete  bankruptcy  of  Aus- 
tria to  the  uncomfortably  reduced  status  of  affairs  in 
France.  They  were  forced  to  buy,  largelj^  from 
America,  the  food  and  clothing  for  their  people  and 
the  munitions  and  stores  for  the  prosecution  of  the 
war;  yet  they  were  able  during  those  years  to  throw 
into  the  currents  of  world  trade  practically  nothing 
with  which  to  create  credits  to  meet  their  debts.  Na- 
tions, like  corporations,  must  go  thru  a  refunding 
process  when  they  have  verged  upon  bankruptcy,  and 
this  process  is  still  in  progress. 

This  excess  of  expenditure  over  income  meant  the 
exhaustion  of  raw  material  and  the  necessity  of  ne- 
gotiating the  purchase  of  more  at  longer  terms  of 
credit  than  the  existing  machinery  of  exchange  made 
any  provision  for.  The  resultant  breakdown  of  ex- 
change between  nations  has  been  partially  the  result 
of  this  impasse;  debts,  no  raw  materials  with  which 
to  produce  the  means  of  paying  them,  few  long  credits 
to  make  raw  material  available. 

5.  hiflation, — The  effect  upon  foreign  exchange 
of  paper  currencies  unsupported  by  adequate  gold 
reserves  (or  of  inflation  as  it  is  usually  called)  is  one 
of  the  most  important  features  of  the  reconstruction 
period. 

Unsupported  currency  is  a  monetary  invention  with 
highly    explosive    properties.      Conscientiously    and 


RESTORATION   PROSPECTS  231 

carefully  handled,  it  may  be  an  effective  means  of 
tiding  over  an  emergency,  but  under  the  control  of 
an  unscrupulous  or  careless  government  it  may  lead  to 
ruin  and  disaster.  Russia  to-day  presents  an  example 
of  criminal  use  of  inflated  currency,  in  fact  the  cur- 
rency inflation  in  that  country  has  simply  run  wild. 
Germany,  Austria,  Hungary,  Jugo-Slavia  and 
Czecho- Slovakia  have  all  been  thru  the  slough  of  un- 
wise issue  and  administration  of  paper  money  and  are 
only  now  beginning  to  reap  the  results  of  the  applica- 
tion of  sound  principles  to  their  monetary  situations. 

Professor  Jevons  said  many  years  ago  regarding 
paper  money: 

The  issue  of  an  inconvertible  money  has  often  been 
recommended  as  a  convenient  means  of  making  a  forced 
loan  from  the  people,  when  the  finances  of  the  govern- 
ment are  in  a  desperate  condition.  It  is  true  that  money 
may  be  thus  abstracted  from  the  people,  and  the  govern- 
ment debts  are  effectually  lessened.  At  the  same  time 
however,  every  private  debtor  is  enabled  to  take  a  forced 
contribution  from  his  creditor.  A  government  should, 
indeed,  be  in  a  desperate  position,  which  ventures  thus  to 
break  all  social  contracts  and  relations  which  it  was 
created  to  preserve.^ 

Many  governments  were  in  desperate  positions  at 
times  during  the  war,  and  there  is  no  doubt  that  prac- 
tically all  of  them  became  victims  of  the  paper  money 
lure  to  a  greater  or  less  degree. 

An  unfortunate  feature  of  currency  inflation  is  that 
the  commercial  life  of  a  nation  absorbs  the  excess 

1  "Money  and  Mechanism  of  Exchange,"  W.  S.  Jevons,  D.  Appleton, 
New  York,  1882. 


232  INTERNATIONAL  EXCHANGE 

money  as  a  sponge  soaks  up  water.  Behind  the  hys- 
terically good  times  that  are  its  first  symptoms  few 
recognize  the  disease  that  will  later  produce  social  un- 
rest, and  if  not  checked  in  time,  financial  panic.  The 
paper  money  once  involved  in  the  credit  structure  of  a 
country  must  be  squeezed  out  slowly  if  a  general  crash 
is  to  be  avoided.  There  is,  then,  every  prospect  of  in- 
convertible paper  money  existing  in  a  number  of 
countrie,:  for  a  considerable  time.  The  result  of  this 
must  be  instability  of  exchange  rates. 

There  is  a  discouraging  element  of  uncertainty  in 
all  business  transacted  with  countries  on  a  paper 
basis.  Xo  man  is  sure  of  what  he  is  going  to  get  in 
return  for  goods  shipped  into  such  a  country.  Nor- 
mally, under  the  gold  standard,  he  knew  he  was  going 
to  get  gold  or  its  equivalent,  transferable  at  fairly 
definite  rates  to  any  other  country  with  which  he  was 
doing  business.  Today  there  is  no  such  assurance. 
With  the  payment  received  for  goods  he  has  shipped 
in  he  may  purchase  goods  for  export  from  the  coun- 
try, or  acquire  other  property.  The  transfer  to  an- 
other country  of  his  funds  in  the  form  of  a  credit  can 
be  made  only  at  a  rate  of  exchange  that  reflects  all  the 
uncertainty  of  the  paper  currency,  which  during  the 
life  of  even  a  short  term  bill  of  exchange  may  suffer  a 
change  in  value  in  comparison  with  the  gold  stand- 
ards that  all  of  the  nations  are  maintaining  in  theory 
and  in  hope  of  recuperation. 

6.  Loss  of  means  of  production. — For  the  purposes 
of  our  present  consideration  the  loss  of  means  of  pro- 


KESTORATION  PROSPECTS  233 

duction  may  be  considered  in  a  widely  inclusive  sense. 
If  we  return  for  a  moment  to  Dean  Johnson's  state- 
ment of  the  United  States  in  account  with  the  world, 
we  shall  see  that  merchandise  overshadows  in  value  all 
other  elements  that  compose  the  vast  total  which  must 
be  cleared  annually  by  exchange  transactions.  What 
is  here  shown  for  the  United  States  would  be  clearly 
shown  in  a  summarized  account  for  any  of  the  com- 
mercial nations.  The  important  bearing  of  the  de- 
struction and  wearing  out  of  means  of  production 
upon  exchange  becomes  apparent.  There  were  no 
depreciation  funds  or  insurance  policies  to  protect 
against  the  wanton  ravages  of  war.  Available  capi- 
tal was  transformed  as  rapidly  as  possible  into  con- 
sumable goods  and  the  necessary  upkeep  of  produc- 
tion facilities  was  largely  neglected. 

7.  Disorganization  of  tL'orking  forces. — To  treat 
fully  the  labor  movement  during  the  reconstruction 
period  as  it  affects  the  exchange  situation  would  lead 
us  off  into  economics,  politics  and  sociology.  We 
must  therefore  be  content  with  little  more  than  a  ref- 
erence to  it.  The  human  element  in  industry  needs 
no  emphasis,  and  it  is  clear  that  casualties  by  the 
million,  as  suffered  by  France  and  Great  Britain,  dis- 
rupted all  the  old  organizations.  ]Moreover  the  men 
taken  from  industrial  life  who  spent  from  three  to 
five  years  in  the  various  armies  found  it  extremely 
difficult  to  adjust  life  and  thought  to  peace  conditions 
until  after  the  lapse  of  months  or  even  years.  j\Ien 
who  remained  in  industry  found  governments  and 


234  INTERNATIONAL  EXCHANGE 

government  contract  holders  ready  to  pay  fabulous 
wages  to  secure  emergency  production.  Politics, 
nearly  everywhere,  crept  into  industry  w^ith  the  usual 
effect  of  too  close  association  of  such  activities  with 
any  kind  of  business,  the  creation  of  false  conditions. 
Moreover  every  industry  in  Europe  was  brought 
under  government  control.  The  ordinar^^  conditions 
of  production  and  sale  were  entirely  superseded. 

To  return  to  peace  time  production  standards  and 
methods  has  meant  reorganization  of  all  the  working 
forces.  It  is  taking  time  to  eradicate  the  false  ideas 
of  the  value  of  labor  and  products  that  developed 
during  the  war,  and  the  social,  political  and  industrial 
unrest  that  attend  the  process  have  all  delayed  the  re- 
turn of  exchange  and  international  finance  to  a  nor- 
mal condition. 

8.  Commercial  parity. — Definite  assurance  regard- 
ing value  to  be  received  has  always  characterized  in- 
ternational business  between  actual  gold  standard 
countries.  From  the  facts  brought  forth  in  our  dis- 
cussion of  paper  currencies  it  became  apparent  that 
such  assurance  has  been  reduced  to  a  minimum,  if  not 
altogether  destroyed.  There  is  no  doubt  that  it  will 
remain  so  reduced  as  long  as  unsupported  paper  cur- 
rencies exist  in  material  quantities.  As  long  as  this 
condition  persists  it  will  be  wise  to  consider  exchange 
rates  to  be  based  to  a  very  considerable  extent  upon 
commercial  parity. 

Commercial  parity  is  based  upon  the  actual  pur- 
chasing power  of  the  current  domestic  medium  of  ex- 


RESTORATION   PROSPECTS  235 

change  of  a  country.  Valuation  of  a  foreign  money 
must  therefore  depend  in  part  upon  the  relative  pur- 
chasing powers  of  the  currencies  in  both  countries  un- 
der consideration.  This  purchasing  power  will,  in 
general,  be  in  inverse  proportion  to  the  amount  of 
inflation  that  has  taken  place. 

Gustav  Cassel  of  Stockholm,  Sweden,  goes  so  far 
as  to  set  forth  the  following  rule:  "When  two  cur- 
rencies have  been  inflated  the  new  normal  rate  of  ex- 
change will  be  equal  to  the  old  rate  multiplied  by  the 
quotient  of  the  degrees  of  inflation  in  those  countries." 
This  signifies  that  if  the  rates  of  inflation  in  two  coun- 
tries are  respectively  320  to  100  and  240  to  100,  the 
new  rate  of  exchange  will  be  %  of  the  old  rate.  Two 
serious  objections  to  the  acceptance  of  this  rule  are 
that  rates  of  depreciation  are  notoriously  hard  to  de- 
termine, and  purchasing  power  per  miit  can  never  be 
definitely  known  until  after  the  event. 

We  have  seen  that  payments  received  in  any  coun- 
try operating  with  a  paper  currency  must  in  most 
cases  be  converted  into  goods  to  permit  their  with- 
drawal without  serious  loss.  It  follows,  therefore, 
that  the  amount  of  goods  obtainable  per  unit  must 
play  a  predominant  part  in  fixing  the  international 
value  of  that  unit.  Thus  in  a  country  where  prices 
are  falling  the  value  of  its  currency  should  appreciate 
in  terms  of  the  currencies  of  countries  where  prices 
are  going  up,  or  are  falling  less  rapidly. 

Without  accepting  in  full  the  theory  as  set  forth 
by  Professor  Cassel,  it  may  be  granted  that  the  facts 


£36  INTERNATIONAL  EXCHANGE 

back  of  it  will  exert  a  strong  influence  upon  exchange 
rates  for  some  time  to  come.  Index  numbers  based 
upon  the  cost  of  commodities  take  on  new  importance 
when  considered  in  this  connection.  Even  tho  they 
are  always  the  records  of  past  performances,  they 
will,  when  reduced  to  a  common  basis,  show  by  com- 
parison future  tendencies  of  the  exchange  rates. 

9.  The  sensitive  condition  of  exchange, — During 
1920  there  were  many  events  that  showed  an  influence 
on  exchange  rates  out  of  all  proportion  to  their  nor- 
mal effects.  Wars  and  rumors  of  wars  drove  quota- 
tions up  and  down,  and  almost  every  conference  of 
the  Allied  Premiers  or  of  the  Supreme  Council  of  the 
Allied  Nations  gave  rise  to  new  reports  of  dissolving 
or  solidifying  international  friendships,  and  to  rumors 
of  new  agreements  regarding  the  fixing  of  the 
amounts  and  the  terms  of  payment  of  the  indemnities 
by  the  central  powers.  Careful  study  of  the  ex- 
change rates  quoted  each  day  as  these  bits  of  news  and 
gossip  became  public,  shows  how  quickly  they  demon- 
strated the  favorable  or  unfavorable  opinion  of  the 
world  of  business. 

The  great  strike  and  the  subsequent  change  of 
methods  of  management  in  the  Italian  metal  indus- 
tries gave  impetus  to  the  slump  of  Italian  exchange. 
The  coal  strike  in  Great  Britain  by  its  first  serious 
threatenings  drove  sterling  down  several  cents  on  the 
pound  but  caused,  within  a  very  short  time,  a  decided 
movement  of  the  rate  in  favor  of  Great  Britain.  The 
uncertainty  of  what  the  final  adjustment  of  the  wages 


RESTORATION  PROSPECTS  237 

of  the  coal  miners  would  be  on  the  first  of  January, 
1921,  continued  to  react  against  sterling  quotations 
in  Xew  York  right  up  to  the  end  of  1920.  These  in- 
stances merely  exemplify  influences  that  have  been 
operating  to  keep  the  exchange  quotations  fluctuating 
with  a  frequency  never  before  experienced  during  the 
great  industrial  era  of  the  nineteenth  and  twentieth 
centuries. 

10.  Financial  reconstruction  and  its  effects, — The 
beginning  of  the  financial  reconstruction  process  was 
marked  by  urgent  calls  for  loans  by  the  distressed 
countries.  It  was  confidently  expected  that  very 
large  credits  could  be  arranged  quickly  and  easily  in 
New  York.  As  we  have  noted,  this  expectation  was 
not  fulfilled.  Loans  were  floated,  it  is  true,  both  in 
London  and  Xew  York  but  they  were  small  in  com- 
parison to  the  needs.  Belgium,  for  example,  had  se- 
cured before  the  middle  of  1920  about  £13,000,000  in 
London,  over  two-thirds  of  which  came  from  the  Brit- 
ish government,  the  remainder  being  subscribed  by  a 
syndicate  of  London  bankers.  From  Xew  York  a 
similar  syndicate  provided  $50,000,000  but  these 
large  sums  failed  to  give  more  than  a  temporary  im- 
provement to  the  exchange  rate. 

All  the  countries  that  secured  loans  indulged  in  an 
illusory  hope  that  their  rates  of  exchange  would  be 
quickly  restored  to  par.  The  exhaustion  of  these  new 
credits  showed  the  futility  of  such  hope,  for  the  rates 
at  once  went  from  bad  to  worse.  The  demands  of  all 
continental  Europe  were  too  great  for  the  lending 


238  IXTERXATIOXAL  EXCHANGE 

countries  to  meet.  The  needs  of  one  countn^  might 
have  been  fully  satisfied  but  the  urgent  cries  of  a 
dozen  produced  a  loss  of  confidence. 

The  whole  European  continent  was  prey  to  the  one 
disease,  differing  only  in  intensity  and  curability. 
The  same  well  known  causes  of  depreciation  were  to 
be  found  everywhere.  The  balance  of  exports  and 
imports  was  completely  upset.  Imports  had  to  be 
made,  yet  there  were  few  exports.  Foodstuffs,  ma- 
chinery and  raw  materials  were,  in  the  circumstances, 
inelastic  demands  that  had  to  be  satisfied  and  pay- 
ment made  at  high  prices.  Every  country  was  ex- 
hausting its  stock  of  investment  securities  salable  in 
more  fortunate  lands.  All  such  resources  available 
for  conversion  into  foreign  exchange  have  been  con- 
tinually diminishing  in  proportion  to  the  volume  of 
business  to  be  cleared,  and  the  inevitable  consequence 
has  been  a  continual  tho  spasmodic  rise  in  the  ex- 
change rates  against  such  countries. 

11.  Exportation  of  cajntal. — The  sale  of  securities 
reached  such  a  volume  that  many  of  the  European 
governments  decided  upon  the  choice  of  what  they 
considered  the  lesser  evil,  namely,  a  further  fall  in 
their  rates  of  exchange  as  quoted  in  Xew  York  and 
London.  France  had  taken  the  lead  in  restricting 
such  international  movements  of  capital  hy  the  estab- 
lishment of  the  Paris  Exchange  Commission  in  July, 
1917.  Other  countries  followed  her  example,  altho 
the  success  of  the  scheme  cannot  be  given  higher 
praise  than  to  say  that  it  has  served  to  retard  the  up- 


RESTORATION  PROSPECTS  239 

ward  flight  of  rates.  Again  using  Belgium  as  an 
example  we  shall  quote  from  Professor  Maurice  An- 
siaux  a  description  of  the  measures  taken  to  restrict 
the  movement  of  capital  from  that  country. 

By  order  in  Council  of  March  28th,  1919,  the  exporta- 
tion of  funds,  securities,  and  coupons  was  consequently 
prohibited,  as  well  also  the  sale  of  securities  in  Belgium 
for  foreign  account,  unless  the  proceeds  were  reinvested 
in  Belgian  securities,  or  the  securities  themselves  had  been 
imported  before  the  war.  The  Decree  also  set  up  an 
Exchange  Committee,  in  which  the  non-official  element 
(bankers,  manufacturers,  and  merchants)  was  predomi- 
nant, but  at  the  same  time  including  representatives  of 
the  different  public  departments  concerned.  Its  function 
was  two-fold.  It  was  to  apply  to  the  needs  of  economic 
reconstruction  such  foreign  credits  as  had  been  placed  at 
the  disposal  of  the  Government.  For  this  purpose  it 
examined  the  requests  for  exchange  which  were  submitted 
to  it,  and  rejected  those  which  did  not  appear  to  be  con- 
nected with  the  work  of  reconstruction,  thereby  relega- 
ting them  to  the  free  market.  In  the  second  place  the 
Committee  was  called  upon  to  give  its  opinion  about  the 
special  permissions  given  for  the  export  of  capital  (secu- 
rities, coupons,  banknotes,  or  coin),  which  the  Govern- 
ment had  reserved  to  itself  the  right  to  grant  in  excep- 
tional circumstances. 

The  Exchange  Committee  exercised  its  functions  regu- 
larly for  several  months.  But,  later  on,  its  activity  was 
gradually  diminished  until  at  last,  in  the  course  of  the 
summer  of  1919,  it  quietly  expired.  Until  the  end  of  the 
year  the  market  was  left  entirely  to  itself.  During  that 
time  rates  were  rising,  and  towards  the  end  of  January 
they  started  violently  upwards.  Industry  and  com- 
merce were  complaining  of  the  increasing  costliness  of 
imported  raw  materials;  the  cost  of  living  was  rising  higher 
and  higher,  provoking  strike  after  strike  in  the  public 


240  INTERNATIONAL  EXCHANGE 

services.  The  expenses  of  provisioning  the  country  were 
becoming  daily  a  more  onerous  charge  upon  the  public 
purse. 

This  was  the  moment  at  which  the  Government 
judged  it  necessary  to  intervene  energetically.  On 
January  30th  a  decree  was  published  establishing  a  strict 
control  over  exchange  operations.  All  traffic  in  bills  and 
currencies  was  forbidden,  except  such  as  was  occasioned 
by  genuine  commercial  transactions.  Bankers,  exchange 
brokers,  and  all  other  persons  operating  in  foreign  ex- 
change were  required  to  keep  a  register  in  which  all  tran- 
sactions involving  exchange  were  to  be  recorded,  including 
sales  of  Belgian  francs  abroad.  Heavy  penalties  were 
provided  for  breaches  of  these  regulations.  Finally,  the 
Exchange  Committee  was  superseded  by  a  Commission 
consisting  of  four  members  nominated  by  the  Govern- 
ment and  two  members  nominated  by  the  National  Bank. 
The  majority  on  this  new  body,  therefore,  no  longer  be- 
longs to  the  business  world,  but  applies  itself  in  a  far  more 
rigorous  and  systematic  spirit  to  the  administration  of 
the  regulations,  which  themselves  have  been  made  more 
strict.  The  reason  for  this  is  that  in  the  more  serious  con- 
ditions of  today  the  most  energetic  measures  are  required^ : 

Belgium's  action  in  this  connection  is  typical  of  what 
has  been  done  in  many  of  the  European  countries,  and 
reflects  the  unceasing  and  strenuous  efforts  of  the  na- 
tions to  get  back  to  a  stable  and  self  supportmg 
economic  and  financial  basis.  It  is,  however,  inter- 
esting to  note  that  in  February,  1921,  the  Belgium 
government  gave  up  this  effort  to  control  artificially 
the  market  for  securities  and  decided  that  it  was  the 
part  of  w^isdom  to  let  matters  take  their  course. 

12.  Efforts  for  concerted  action. — Early  in  1920 

1  "Belgian  Exchange  Since  the  War."    The  Economic  Journal,  London, 
Eng.,  June,  1920. 


RESTORATION   PROSPECTS  241 

the  Supreme  Council  of  the  AlHed  Nations  reaHzed 
the  necessity  for  some  concerted  action  on  the  financial 
status  of  the  various  countries,  and  called  a  small 
group  of  the  most  prominent  financiers  of  Europe  to 
advise  on  the  best  means  to  secure  it.  The  result  of 
their  advice  was  the  summoning  of  an  international 
monetary  conference  which  met  at  Brussels  in  1920. 
The  task  set  before  this  body  was  to  secure  as  com- 
plete a  presentation  as  possible  of  the  economic  and 
financial  situation  of  the  world,  and  by  an  interchange 
of  opinion  and  experience  to  assist  each  country  to 
arrive  at  the  soundest  policy  possible  for  dealing  with 
its  existing  difficulties.  Some  account  of  tliis  con- 
ference is  given  in  the  Appendix. 

13.  International  and  national  issues. — Interna- 
tional gatherings  such  as  that  held  in  Brussels  are 
very  useful  in  clearing  the  atmosphere  and  bringing 
out  the  fact  that  many  countries  are  suffering  the 
same  troubles.  If  they,  however,  encourage  the  na- 
tions to  postpone  reform  pending  international  delib- 
eration or  even  to  expect  that  international  action  will 
be  the  chief  agency  in  bringing  them  back  to  solvency, 
their  influence  is  less  beneficial.  Without  discounting 
the  aid  which  one  nation  can  render  to  another  it  is 
fair  to  say  that  nations  which  rely  exclusively  upon  an 
international  doctor  or  an  international  nurse  to  coax 
them  back  to  health  can  count  on  remaining  sick  for  a 
long  time. 

Recent  years  have  brought  out  more  strongly  than 
ever  before  the  existence  of  international  obligations. 

XVIII — 17 


242  INTERNATIONAL  EXCHANGE 

It  is,  however,  to  be  feared  that  the  continued  insist- 
ence upon  them  will  lead  to  a  reaction.  In  the  emer- 
gency of  a  world  crisis  such  international  obligations 
have  a  compelling  force,  but  it  is  the  essence  of  an 
emergency  to  be  temporary.  The  feeling  grows  daily 
that  the  time  must  come  soon  when  nations  must 
stand  upon  their  own  feet.  Just  at  the  present  time 
there  is  undoubtedly  more  prospect  of  a  speedy  res- 
toration of  normal  conditions  tlii'u  a  calm  survey  of 
what  each  nation  can  do  for  itself  and  a  firm  resolu- 
tion to  do  it  than  in  a  concert  of  nations  which  may 
restore  harmony  in  economic  affairs. 

14.  National  duty. — It  is  the  duty  of  every  nation 
to  put  its  own  house  in  order.  In  many  cases  the  task 
is  a  hard  one  but  it  is  to  be  remembered  that  there  is 
no  easy  road  to  affluence  and  well-being.  Nations 
that  have  arrived  at  a  position  of  economic  prestige  in 
the  world's  affairs  in  times  past  have  done  it  thru  the 
homely  virtues  of  working  and  saving.  Nothing  else 
will  achieve  a  similar  result  today.  In  the  stress 
and  strain  of  war,  expedients  were  a  necessity  but  they 
cannot  be  kept  up  indefinitely.  Every  year  it  be- 
comes more  and  more  difficult  to  adjust  interna- 
tional payments  on  the  basis  of  credits.  The  United 
States  and  other  countries  that  are  in  a  favorable  posi- 
tion to  lend  capital  to  the  world  must  have  the  prom- 
ise of  a  definite  return  from  such  loans.  The  diffi- 
culties of  the  situation  are  very  great  both  for  the 
creditor  and  for  the  debtor  nations. 

15.  Difficulties  in  extending  credit. — It  is  urged 


RESTORATION  PROSPECTS  243 

sometimes  frantically  that  more  than  it  has  ever  done 
in  the  past  the  United  States  must  lend  its  credit  to 
the  other  nations.  It  is  speciously  pointed  out  that 
only  thru  such  loans  of  capital  and  credit  in  times  past 
did  Great  Britain  gain  its  financial  ascendency  and  we 
are  told  that  only  by  following  in  the  same  path  can 
the  United  States  retain  its  place  as  the  world's 
banker  and  as  a  creditor  nation. 

It  is  undoubtedly  true  that  the  financial  interests 
of  the  United  States  have  until  recently  confined  their 
attention  largely  to  home  investments.  They  have 
been  under  no  necessity  of  looking  abroad  for  the 
employment  of  capital.  It  is  also  true  and  not  to  be 
gainsaid  that  the  interest  in  foreign  investments  will 
not  grow  materially  until  the  time  comes  that  they 
yield  a  greater  profit  than  those  at  home.  American 
financiers  are  no  less  keen  to  make  a  profit  than  are 
their  British  brethren.  In  like  conditions  they  will  act 
in  the  same  way,  loaning  money,  or  rather  capital, 
freely. 

There  is  not  a  complete  parallel  between  the  posi- 
tion of  the  United  States  today  and  that  of  Great 
Britain  before  the  war.  An  analysis  of  foreign  in- 
vestments, that  is,  credits  to  debtor  nations,  will  show 
that  for  the  most  part  that  they  have  been  made  for 
the  purpose  of  supplying  fixed  capital  for  the  indus- 
trial development  of  the  debtor  nation.  They  have 
been  used  sparingly  for  the  purpose  of  supplying  such 
nations  with  working  capital  and  not  at  all  for  the 


244  INTERNATIONAL  EXCHANGE 

purpose  of  allowing  the  debtor  nation  to  purchase 
consumable  goods. 

Now  the  need  of  Europe  today  is  in  the  first  in- 
stance for  food  and  clothing,  in  the  second  instance 
for  raw  materials  and  in  the  third  for  fixed  capital. 
The  problem  is  to  keep  the  people  alive  and  to  get 
them  to  work  rather  than  to  increase  the  facilities  for 
the  production.  American  philanthropy  has  not  been 
deaf  to  the  cry  of  starving  millions  in  Europe  but  it 
is  obvious  that  widespread  destitution  is  not  a  basis 
for  business  investment.  Nor  is  it  a  simple  matter 
to  provide  for  European  producers  the  raw  material 
necessary  for  the  resumption  of  industry.  Some  op- 
erations of  this  character  are  contemplated  by  cor- 
porations organized  under  the  Edge  Act,  but  they 
represent  a  comparatively  novel  form  of  international 
finance,  and  a  rapid  development  is  hardly  to  be  ex- 
pected. 

Thus  it  will  be  seen  that  there  is  far  from  being  an 
exact  parallel  between  the  loans  which  Great  Britain 
has  made  in  times  past  for  the  development  of  rich, 
tho  backward,  countries,  and  the  further  extension  of 
credit  by  the  United  States  to  the  stricken  peoples  of 
Europe.  The  mere  following  of  British  methods  will 
not  meet  the  situation.  New  and  more  complex  credit 
forms  must  be  developed  and  the  process  cannot  be 
hurried. 

16.  Need  of  increased  production. — These  con- 
siderations indicate  that  in  the  countries  suffering 
from  a  low  rate  of  exchange  with  the  United  States 


RESTORATION  PROSPECTS  245 

the  solution  of  the  exchange  question  lies  in  increased 
production  rather  than  in  fiscal  manipulations.  The 
sooner  they  realize  this  as  nations  and  as  individuals 
and  the  more  they  bend  their  backs  to  bear  the  bur- 
dens which  war  has  imposed,  the  sooner  may  they 
hope  that  their  international  economic  relations  will 
return  to  a  sane  and  normal  basis. 

It  is  one  of  the  encouraging  signs  of  the  times  that 
with  greater  or  less  energy  and  with  greater  or  less 
intelligence  the  nations  are  working  towards  the  res- 
toration of  the  former  conditions.  They  look  for- 
ward to  the  day  when  the  old  par  of  exchange  will 
be  restored  and  the  fetters  that  shackle  their  trade  be 
broken.  It  is  to  their  interest  and  to  the  interest  of 
civilization  as  a  whole  that  such  a  result  be  speedily 
obtained. 

REVIEW 

Outline  briefly  the  four  reasons  for  the  disorganization  of  inter- 
national exchange. 

Define  the  word  inflation  as  applied  to  currencies. 

Why  is  inconvertible  paper  money  a  usual  result  of  war  ? 

What  are  the  effects  of  currency  inflation  on  the  exchange  rates 
of  a  country  ? 

Define  commercial  parity.  Why  has  it  become  of  great  im- 
portance in  connection  with  foreign  exchange  ? 

Describe  the  difficulties  which  the  United  States  encounters  in 
extending  credit  to  Europe  in  the  present  juncture. 

NOTE:  Numerous  questions  of  business  practice  and  procedure  are 
discussed  in  detail  in  the  Modern  Business  Reports.  The  current  hst 
contains  the  following  Reports  which  in  their  subject  matter  are  more 
or  less  refated  to  questions  arising  in  a  consideration  of  International 
Exchange: 

4,  Investment  Trusts; 
93,  Organizing  Export  Combinations  Under  the  Webb  Act. 


APPENDIX  A 
THE  BRUSSELS  COXFEREXCE 

Representatives  of  thirty-nine  nations  assembled 
for  the  conference  and  because  of  the  volume  of  evi- 
dence and  opinion  to  be  recorded,  and  the  different 
phases  of  the  situation  to  be  considered,  divided  the 
work  among  commissions  composed  of  the  best  quali- 
fied experts  along  each  particular  line.  These  com- 
missions reported  in  the  form  of  resolutions  which 
were  adopted  by  the  conference. 

Many  of  the  resolutions  are  rather  axiomatic  in 
character,  tho  it  must  be  admitted  that  their  reitera- 
tion in  this  way  called  salutory  attention  to  the  fact 
that  they  were  being  disregarded  to  a  greater  or  less 
degree  by  many  peoples  and  governments. 

The  conference  crushed  ruthlessly  any  false  hopes 
there  may  have  been  of  possibilities  of  recovery  with- 
out hardships  and  sacrifices.  Emphasis  was  placed 
upon  the  fact  that  industry  must  be  so  organized  as  to 
encourage  maximum  production,  as  only  by  produc- 
tion and  still  more  production  can  international  credit 
relations  be  rehabilitated. 

The  resolutions  proposed  by  the  Commission  on 
Currency  and  Exchange  and  that  upon  International 
Credit  display  the  closest  relationship  to  the  subject  of 
exchange.     We  shall  therefore  give  them  verbatim, 

246 


BRUSSELS  CONFERENCE  247 

Resolutions  ox  Currency  and  Exchange 

The  currency  of  a  country,  in  the  sense  of  the  immediate 
purchasing  power  of  the  community,  includes  (a)  the 
actual  legal  tender  money  in  existence,  and  (6)  any 
promises  to  pay  legal  tender,  e.g.,  as  Bank  balances — 
which  are  available  for  ordinary  daily  transactions. 

The  currencies  of  all  belligerent  and  of  many  other 
countries,  though  in  greatly  varying  degrees,  have  since 
the  beginning  of  the  war  been  expanded  artificially,  re- 
gardless of  the  usual  restraints  upon  such  expansion  (to 
which  we  refer  later)  and  without  any  corresponding  in- 
crease in  the  real  wealth  upon  which  their  purchasing 
power  was  based;  indeed  in  most  cases  in  spite  of  a  serious 
reduction  in  such  wealth. 

It  should  be  clearly  understood  that  this  artificial  and 
unrestrained  expansion,  or  "inflation"  as  it  is  called,  of 
the  currency  or  of  the  titles  to  immediate  purchasing 
power,  does  not  and  cannot  add  to  the  total  real  purchasing 
power  in  existence,  so  that  its  effect  must  be  to  reduce  the 
purchasing  power  of  each  unit  of  the  currency.  It  is,  in 
fact,  a  form  of  debasing  the  currency. 

The  effect  of  it  has  been  to  intensify,  in  terms  of  the 
inflated  currencies,  the  general  rise  in  prices,  so  that  a 
greater  amount  of  such  currency  is  needed  to  procure  the 
accustomed  supply  of  goods  and  services.  Where  this 
additional  currency  was  procured  by  further  "inflation" 
{i.e.y  by  printing  more  paper  money  or  creating  fresh 
credit)  there  arose  what  has  been  called  a  "vicious  spiral" 
of  constantly  rising  prices  and  wages  and  constantly  in- 
creasing inflation,  with  the  resulting  disorganization  of 
all  business,  dislocation  of  the  exchanges,  a  progressive 
increase  in  the  cost  of  living,  and  consequent  labor  unrest. 

Therefore: 

I.  It  is  of  the  utmost  importance  that  the  growth  of  in- 
flation should  he  stopped,  and  this,  altho  no  doubt  very 
difficult  to  do  immediately  in  some  countries,  could 
quickly  be  accomplished  by  (1)  abstaining  from  increasing 


£48  INTERNATIONAL  EXCHANGE 

the  currency  (in  its  broadest  sense  as  defined  above) ,  and 
(2)  by  increasing  the  real  wealth  upon  which  such  cur- 
rency is  based. 

The  cessation  of  increase  in  the  currency  should  not  be 
achieved  merely  by  restricting  the  issue  of  legal  tender. 
Such  a  step,  if  unaccompanied  by  other  measures,  would 
be  apt  to  aggravate  the  situation  by  causing  a  monetary 
crisis.  It  is  necessary  to  attack  the  causes  which  lead  to 
the  necessity  for  the  additional  currency. 

The  chief  cause  in  most  countries  is  that  the  Govern- 
ments, finding  themselves  unable  to  meet  their  expendi- 
tures out  of  revenue,  have  been  tempted  to  resort  to  the 
artificial  creation  of  fresh  purchasing  power,  either  by  the 
direct  issue  of  additional  legal  tender  money,  or  more 
frequently  by  obtaining — especially  from  the  Banks  of 
Issue,  which  in  some  cases  are  unable  and  in  others  un- 
willing to  refuse  them — credits  which  must  themselves  be 
satisfied  in  legal  tender  money.    AYe  say,  therefore,  that — 

II.  Governments  must  limit  their  expenditure  to  their 
revenue.  {We  are  not  considering  here  the  finance  of  re- 
constructing devastated  areas.) 

III.  Banks,  and  especially  Banks  of  Issue,  should  be 
freed  from  political  pressure  and  should  be  conducted  solely 
on  the  lines  of  prudent  finance . 

But  the  Governments  are  not  the  only  offenders  in  this 
respect;  other  parties,  and  especially  in  some  countries 
the  municipalities  and  other  local  authorities,  have  raised 
excessive  credits  w^hich  in  the  same  way  multiply  the  titles 
to  purchasing  power. 

Nor  will  it  be  sufficient,  for  the  purpose  of  checking 
further  inflation,  that  additional  issues  of  legal  tender  or  the 
granting  of  additional  credits  should  cease;  since  the  float- 
ing debts  o£  Government  and  other  authorities  constitute 
in  themselves  a  form  of  potential  currency,  in  that,  except 
in  so  far  as  they  are  constantly  renewed,  their  amount  will 
come  to  swell  the  total  currency  in  existence;  conse- 
quently— 

IV.  The  creation  of  additional  credit  should  cease  and 


BRUSSELS  CONFERENCE  249 

Governments  and  municipalities  should  not  only  not  increase 
their  floating  debts,  hut  should  begin  to  repay  or  fund  them 
by  degrees. 

In  normal  times  the  natural  and  most  effective  regulator 
of  the  volume  and  distribution  of  credit  is  the  rate  of 
interest  which  the  central  Banks  of  Issue  are  compelled, 
in  self-preservation  and  in  duty  to  the  community,  to 
raise  when  credit  is  unduly  expanding.  It  is  true  that 
high  money  rates  would  be  expensive  to  Governments 
which  have  large  floating  debts,  but  we  see  no  reason  why 
the  community  in  its  collective  capacity  {i.e.,  the  Gov- 
ernment) should  be  less  subject  to  the  normal  measure  of 
restricting  credit  than  the  individual  members  of  the  com- 
munity. In  some  countries,  however,  the  financial  ma- 
chinery has  become  so  abnormal  that  it  may  be  difficult 
for  such  corrective  measures  to  be  immediately  applied. 
We  recommend,  therefore,  that — 

V.  Until  credit  can  be  controlled  merely  by  the  normal 
influence  of  the  rate  of  interest,  it  should  only  be  granted  for 
real  economic  needs. 

It  is  impossible  to  lay  down  any  rule  as  to  the  "proper 
rates"  of  discount  or  interest  for  different  countries. 
These  rates  will  depend  not  only  on  the  supply  and  demand 
at  different  times  but  also  on  other  factors  often  of  a 
psychological  nature.  It  may,  indeed,  confidently  be  said 
that  when  once  the  arbitrary  increase  of  inflation  ceases 
and  when  the  Banks  of  Issue  are  able  successfully. to  per- 
form their  normal  functions,  rates  will  find  their  own 
proper  level. 

The  complementary  steps  for  arresting  the  increase  of 
inflation  by  increasing  the  wealth  on  which  the  currency  is 
based,  may  be  summed  up  in  the  words:  increased  produc- 
tion and  decreased  consumption. 

The  most  intensive  production  possible  is  required  in 
order  to  make  good  the  waste  of  war  and  arrest  inflation, 
and  thus  to  reduce  the  cost  of  living;  yet  we  are  witnessing 
in  many  countries  production  below  the  normal,  together 
with  those  frequent  strikes  which  aggravate  instead  of 


250  INTERNATIONAL  EXCHANGE 

help  to  cure  the  present  shortage  and  clearness  of  commodi- 
ties. When  diminution  in  the  Government's  demands 
frees  more  credits  for  trade  and  for  the  recuperation  of  the 
world,,  when  inflation  has  ceased  and  prices  cease  to  rise, 
and  when  the  general  unsettlement  caused  by  the  war 
subsides,  it  is  probable  that  great  improvement  will  be 
seen  in  productive  activity.  Yet,  in  our  opinion,  the  pro- 
duction of  wealth  is  in  many  countries  suffering  from  a  cause 
which  it  is  more  directly  in  the  power  of  Governments 
to  remove,  viz,  the  control  in  various  forms  which  was 
often  imposed  by  them  as  a  war  measure  and  has  not 
yet  been  completely  relaxed.  In  some  cases,  business  has 
even  been  taken  by  Governments  out  of  the  hands  of  the 
private  trader,  whose  enterprise  and  experience  are  a  far 
more  potent  instrument  for  the  recuperation  of  the 
country. 

Another  urgent  need  is  the  freest  possible  international 
exchange  of  commodities .  With  this  another  Commission 
will  deal,  but  we  feel  that  our  recommendations  here  on 
inflation  would  not  be  complete  without  adding  that — 

VI.  Commerce  should  as  soon  as  possible  be  freed  from 
control i  and  impediments  to  international  trade  removed. 

Equally  urgent  is  the  necessity  for  decreased  consump- 
tion in  an  impoverished  world  where  so  much  has  been 
destroyed  and  where  productive  power  has  been  impaired . 
It  is,  therefore,  specially  important  at  present  that,  both 
on  public  and  private  account,  and  not  only  in  impover- 
ished countries,  but  in  every  part  of  the  world — 

VII.  All  superfluous  expenditures  should  be  avoided. 
To  attain  this  end,  the  enlightenment  of  public  opinion 

is  the  most  powerful  lever.  If  the  wise  control  of  credit 
brings  dear  money,  this  result  will  in  itself  help  to  pro- 
mote economy. 

We  pass  now  from  inflation  and  its  remedies  to  the  other 
points  submitted  to  us. 

Without  entering  into  the  question  whether  gold  is  or  is 
not  the  ideal  common  standard  of  value,  we  consider  it 
most  important  that  the  world  should  have  some  common 


BRUSSELS  CONFERENCE  251 

standard,  and  that,  as  gold  is  today  the  nominal  standard 
of  the  civilized  world — 

VIII.  It  is  highly  desirable  that  the  countries  which 
have  lapsed  from  an  elective  gold  standard  shoidd  return 
thereto. 

It  is  impossible  to  say  how  or  when  all  the  older  coun- 
tries would  be  able  to  return  to  their  former  measure  of 
effective  gold  standard,  or  how  long  it  would  take  the 
newly  formed  countries  to  establish  such  a  standard. 
But  in  our  opinion — 

IX.  It  is  useless  to  attempt  to  fix  the  ratio  of  existing 
fiduciary  currencies  to  their  nominal  gold  value;  as,  unless 
the  condition  of  the  country  concerned  were  sufficiently 
favorable  to  make  the  fixing  of  such  ratio  unnecessary,  it 
could  not  be  maintained. 

The  reversion  to,  or  establishment  of,  an  effective  gold 
standard  would  in  many  cases  demand  enormous  deflation 
and  it  is  certain  that  such — 

X.  Defiation,  if  and  ivhen  undertaken^  viust  he  carried 
out  gradually  and  with  great  cautioii;  otherwise  the  dis- 
turbance to  trade  and  credit  might  prove  disastrous. 

XI.  We  cannot  recommend  any  attempt  to  stabilize  the 
value  of  gold  and  we  gravely  doubt  whether  such  attempt 
could  succeed;  but  this  question  might  well  be  submitted  to 
the  Committee  to  which  we  refer  later,  if  it  should  be  ap- 
pointed. 

XII.  We  believe  that  neither  an  International  Currency 
nor  an  International  Unit  of  Account  would  serve  any  use- 
ful purpose  or  remove  any  of  the  difficulties  from  which 
International  Exchange  suffers  today. 

XIII.  We  can  find  no  justification  for  supporting  the 
idea  that  foreign  holders  of  Bank  notes  or  Bank  balances 
should  be  treated  differently  from  native  holders. 

XIV.  In  countries  where  there  is  no  central  Bank  of 
Issue,  one  should  be  established,  and  if  the  assistance  of 
foreign  capital  were  required  for  the  promotion  of  such  a 
Bank,  some  form  of  international  control  might  be  re- 
quired. 


252  INTERNATIONAL  EXCHANGE 

XV.  Attempts  to  limit  fluctuations  in  Exchange  by  im- 
posing artificial  control  on  Exchange  operations  are  futile 
and  mischievous.  In  so  far  as  they  are  effective  they  falsify 
the  market,  tend  to  remove  natural  correctives  to  such 
fluctuations  and  interfere  with  free  dealings  in  forward 
Exchange  which  are  so  necessary  to  enable  traders  to 
eliminate  from  their  calculations  a  margin  to  cover  risk  of 
exchange,  which  would  otherwise  contribute  to  the  rise 
in  prices.  Moreover,  all  Government  interference  with 
trade,  including  Exchange,  tends  to  impede  that  improve- 
ment of  the  economic  conditions  of  a  country  by  which 
alone  a  healthy  and  stable  exchange  can  be  secured. 

We  support  the  suggestion  that — 

XVI.  A  Committee  should  he  set  up  both  for  continuing 
the  collection  of  the  valuable  financial  statistics  that  have 
been  furnished  for  this  Conference  and  also  the  further 
investigation  of  currency  policy. 

RESOLUTIONS    ON   INTERNATIONAL   CREDIT. 

I.  The  Conference  recognizes  in  the  first  place  that  the 
difiiculties  which  at  present  lie  in  the  way  of  international 
credit  operations  arise  almost  exclusively  out  of  the  dis- 
turbance caused  by  the  war,  and  that  the  normal  working 
of  financial  markets  cannot  be  completely  re-established 
unless  peaceful  relations  are  restored  between  all  peoples 
and  the  outstanding  financial  questions  resulting  from  the 
war  are  made  the  subject  of  a  definite  settlement  which  is 
put  into  execution. 

II.  The  Conference  is,  moreover,  of  opinion  that  the 
revival  of  credit  requires  as  primary  conditions  the  restor- 
ation of  order  in  public  finance,  the  cessation  of  inflation, 
the  purging  of  currencies,  and  the  freedom  of  commercial 
transactions.  The  resolutions  of  the  Commission  on  In- 
ternational Credits  are  therefore  based  on  the  resolutions 
of  the  other  Commissions. 

III.  The  Conference  recognizes,  however,  that  this 
general  improvement  in  the  situation  requires  a  considera- 


BRUSSELS  CONFERENCE  253 

ble  period  of  time,  and  that  in  present  circumstances  it 
is  not  possible  for  certain  countries  to  restore  their  eco- 
nomic activity  without  assistance  from  abroad.  This 
assistance  is  required  for  periods  which  exceed  the  normal 
term  of  commercial  operations. 

IV.  The  Conference  is  of  opinion  that  in  principle 
the  resources  out  of  which  this  assistance  is  to  be  provided 
should  be  found  from  the  savings  of  the  lending  countries 
and  must  not  result  in  undue  increase  of  the  fiduciary 
circulation — that  is  to  say,  in  the  creation  or  extension  of 
a  disproportion  between  means  of  payment  and  the  genu- 
ine requirements  of  business. 

V.  The  Conference  believes,  on  the  other  hand,  that 
this  assistance  can  only  be  effectively  accorded  to  coun- 
tries which  are  prepared  to  assist  one  another  in  the 
restoration  of  economic  life,  and  to  make  every  effort 
to  bring  about  within  their  own  frontiers  the  sincere 
collaboration  of  all  groups  of  citizens  and  to  secure  condi- 
tions which  give  to  work  and  thrift  liberty  to  produce  their 
full  results. 

VI.  The  Conference  does  not  believe  that,  apart  from 
particular  decisions  dictated  by  national  interests  or  by 
considerations  of  humanity,  credits  should  be  accorded 
directly  by  Governments. 

VII.  It  appears  to  the  Conference  that  one  of  the 
chief  obstacles  to  the  granting  of  credits  is  the  absence  in 
borrowing  countries  of  sufficient  security  for  ultimate  re- 
payment. The  Conference  therefore  studied  with  atten- 
tion in  the  light  of  the  general  considerations  enumerated 
above  all  the  proposals  presented  with  a  view  to  creating 
guarantees  which  would  provide  satisfactory  security  for 
exporters. 

The  Conference  has  been  forced  to  recognize  that  no 
single  system  could  by  itself  suffice  to  provide  for  the  many 
different  needs  of  the  various  countries,  and  that  it  is 
necessary  to  indicate  a  series  of  measures  sufficiently 
elastic  to  be  adapted  afterwards  to  every  variety  of  cir- 
cumstances . 


254  IXTERXATIOXAL  EXCHANGE 

For  these  reasons  the  Conference  decided  to  make  the 
following  recommendations: 

VIII.  An  international  organization  should  be  formed 
and  placed  at  the  disposal  of  States  desiring  to  have  re- 
sort to  credit  for  the  purpose  of  paying  for  their  essential 
imports.  These  States  would  then  specify  the  assets 
v/hich  they  are  prepared  to  pledge  as  security  for  the  sake 
of  obtaining  credit,  and  would  come  to  an  understanding 
with  the  international  organization  as  to  the  conditions 
under  which  these  a,ssets  would  be  administered. 

The  bonds  issued  against  this  guarantee  would  be  used 
as  collateral  for  credit  intended  to  cover  the  cost  of  com- 
modities. 

A  plan  based  upon  these  principles  is  developed  in  the 
Annex.  It  has  been  devised  to  enable  States  to  facilitate 
the  obtaining  of  commercial  credits  by  their  nationals.  It 
is  easy  to  see  that  the  scheme  is  susceptible  of  develop- 
ment in  various  directions,  and  that  some  of  its  provisions 
might  be  adapted  so  as  to  facilitate  the  extension  of  credit 
direct  to  public  corporations. 

A  Committee  of  financiers  and  business  men  should  be 
nominated  forthwith  by  the  Council  of  the  League  of  Na- 
tions for  the  purpose  of  defining  the  measures  necessary  to 
give  practical  effect  to  this  proposal . 

IX.  It  has  been  represented  to  the  Conference  that 
more  complete  results  might  be  achieved  if  the  bonds  used 
as  collateral  were  to  carry  some  international  guarantee. 

The  Conference  sees  no  objection  to  the  further  con- 
sideration of  this  proposal .  The  Committee  referred  to  in 
paragraph  VIII  above  might  usefully  consider  the  condi- 
tions under  which  it  could  be  applied. 

X.  It  has  also  been  represented  to  the  Conference  that 
an  extension  on  international  lines  of  the  existing  system  of 
-export  credit  insurance  would  in  many  instances  be  of 
great  \'alue  in  developing  trade  with  countries  where 
political  and  social  conditions  give  rise  to  an  anxiety  which 
is  often  exaggerated  by  exporters.     The  Conference  be- 


BRUSSELS  CONFERENCE  255 

lieves  that  an  extension  of  this  kind  is  worthy  of  considera- 
tion, and  that  it  should  be  examined  in  detail  by  experts. 

XI.  The  attention  of  the  Conference  has  been  called  to 
the  present  system  of  "finishing  credits,"  that  is  to  say,  of 
credits  under  which  a  lien  in  favor  of  the  exporter  or  a 
banker  is  maintained  on  the  raw  material  in  all  its  different 
stages  and  upon  the  proceeds  of  the  manufactured  article. 
This  system  has  suffered  greatly  owing  to  the  lack,  in 
many  countries ,  of  sufficient  legal  protection  for  the  ex- 
porter thruout  the  various  stages  of  importation,  manu- 
facture, re-exportation  and  sale.  The  Conference  would 
suggest  that  the  Council  be  recommended  to  draw  the 
attention  of  the  different  Governments  to  this  question, 
and  to  summon  an  advisory  body  of  legal  experts  and 
business  men  to  specify  the  legislative  action  it  would  be 
desirable  to  take  in  order  to  attain  the  desired  object  in 
each  of  the  countries  concerned. 

XII.  Apart  from  the  above-mentioned  proposals 
which  the  Conference  recommends  the  League  of  Nations 
to  adopt,  and  if  possible  to  apply  in  practice,  the  Con- 
ference believes  that  the  activities  of  the  League  might 
usefully  be  directed  towards  promoting  certain  reforms, 
and  collecting  the  relevant  information  required  to  facili- 
tate credit  operations.  In  this  connection  the  Conference 
considers  it  well  to  draw  attention  to  the  advantages  of 
making  progress  under  each  of  the  following  heads: 

(Ij  unification  of  the  laws  relating  to  bills  of  exchange 
and  bills  of  lading; 

(2)  The  reciprocal  treatment  of  the  branches  of  foreign 
banks  in  different  countries; 

(3)  The  publication  of  financial  information  in  a  clear, 
comparative  form; 

(4)  The  examination  of  claims  by  the  holders  of  bonds 
the  interest  on  which  is  in  arrear; 

(o)  An  international  understanding  on  the  subject  of 
lost,  stolen  or  destroyed  securities; 

(6)  The  establishment  of  an  international  clearing 
house; 


256  INTERNATIONAL  EXCHANGE 

(7)  An  international  understanding  which,  while  en- 
suring the  due  payment  by  everyone  of  his  full  share  of 
taxation,  would  avoid  the  imposition  of  double  taxation 
which  is  at  present  an  obstacle  to  the  placing  of  invest- 
ments abroad. 

XIII.  During  the  course  of  its  deliberations  the  Con- 
ference could  not  fail  to  be  impressed  by  the  fact  that  all, 
or  almost  all,  of  the  many  proposals  submitted  for  its 
consideration  require  at  some  stage  the  active  interven- 
tion of  the  League  of  Nations .  The  Conference  is  unani- 
mously in  sympathy  with  this  tendency,  and  believes  that 
it  is  desirable  to  extend  to  the  problems  of  finance  that 
international  cooperation  which  the  League  of  Nations 
has  inaugurated,  and  which  it  is  attempting  to  promote 
in  order  to  improve  the  general  situation  and  maintain 
the  peace  of  the  world. 

DETAILS   REGARDING   BOND   ISSUE. 

1.  In  order  that  impoverished  nations,  which  under 
present  circumstances  are  unable  to  obtain  accommoda- 
tion on  reasonable  terms  in  the  open  market,  may  be  able 
to  command  the  confidence  necessary  to  attract  funds  for 
the  financing  of  their  essential  imports,  an  international 
commission  shall  be  constituted  under  the  auspices  of  the 
League  of  Nations. 

2.  The  commission  shall  consist  of  bankers  and  business 
men  of  international  repute,  appointed  by  the  Council 
of  the  League  of  Nations. 

3.  The  commission  shall  have  the  power  to  appoint 
sub-commissions  and  to  devolve  upon  them  the  exercise 
of  its  authority  in  participating  countries  or  in  groups  of 
participating  countries. 

4 .  The  Governments  of  countries  desiring  to  participate 
shall  notify  the  commission  what  specific  assets  they  are 
prepared  to  assign  as  security  for  commercial  credits  to  he 
granted  by  the  nationals  of  exporting  countries. 

5.  The  commission,  after  examination  of  these  assets. 


BRUSSELS  CONFERENCE  257 

shall  of  its  own  authority  determine  the  gold  value  of  the 
credits  which  it  would  approve  against  the  security  of 
these  assets. 

6.  The  participating  Government  shall  then  be  author- 
ized to  prepare  bonds  to  the  gold  value  approved  by  the 
commission,  each  in  one  specific  currency  to  be  determined 
on  the  issue  of  the  bond. 

7.  The  date  of  maturity  and  the  rate  of  interest  to  be 
borne  by  these  bonds  shall  be  determined  by  the  partici- 
pating Government  in  agreement  with  the  commission. 

8 .  The  service  of  these  bonds  shall  be  secured  out  of  the 
revenue  of  the  assigned  assets. 

9.  The  assigned  assets  shall  in  the  first  instance  be  ad- 
ministered by  the  participating  Government  or  by  the  in- 
ternational commission  as  that  commission  may  in  each 
case  determine. 

10.  The  commission  shall  at  any  time  have  the  right  of 
making  direct  representations  to  the  Council  of  the 
League  of  Nations  as  to  desirability  of  transferring  the 
administration  of  the  assigned  assets  either  from  the  com- 
mission to  the  participating  Government  or  from  the 
participating  Government  to  the  commission. 

11.  The  decision  of  the  Council  of  the  League  of  Na- 
tions on  this  question  shall  be  binding. 

12.  After  the  preparation  of  these  bonds  the  partici- 
pating Government  shall  have  the  right  to  loan  the  bonds 
to  its  own  nationals,  for  use  by  them  as  collateral  security 
for  importations. 

13.  The  bonds  shall  be  made  out  in  such  currencies  and 
in  such  denominations  as  are  applicable  to  the  particular 
transaction  in  respect  of  which  they  are  issued. 

14.  The  participating  Government  shall  be  free  to  take 
or  not  to  take  security  for  the  loan  of  these  bonds  from  the 
nationals  to  whom  they  are  lent. 

15.  The  maturity  and  the  rate  of  interest  of  the  loan  of 
the  bonds  shall  be  fixed  by  agreement  between  the  partici- 
pating Government  and  the  borrower  of  the  bonds;  they 

XVIII — 18 


258  INTERNATIONAL  EXCHANGE 

need  not  be  the  same  as  the  maturity  and  the  rate  of  in- 
terest of  the  bonds  themselves. 

16.  When  making  appHcation  to  his  Government  for  a 
loan  on  these  bonds,  the  importer  must  furnish  proof  that 
he  has  previously  obtained  from  international  commis- 
sion express  permission  to  enter  into  the  transaction  for 
which  the  bonds  are  to  be  given  as  collateral. 

17.  Each  bond,  before  it  is  handed  over  by  the  partici- 
pating Government  to  the  importer,  shall  be  counter- 
signed by  the  commission  in  proof  of  registration. 

18.  Having  obtained  the  consent  of  the  commission  and 
received  from  them  the  countersigned  bonds,  the  importer 
will  pledge  these  bonds  to  the  exporter  in  a  foreign  coun- 
try for  the  period  of  the  transaction. 

19.  The  exporter  will  return  to  him  on  their  due  dates 
the  coupons  of  the  pledged  bonds,  and  the  bonds  them- 
selves on  the  completion  of  the  transaction. 

20.  On  receipt  of  the  coupons  and  the  bonds  respec- 
tively, the  importer  will  return  them  to  his  Government. 

21.  Bonds  returned  to  the  participating  Government 
shall  be  cancelled  and  may  subsequently  be  replaced  by 
other  bonds,  either  in  the  same  or  in  a  different  currency, 
up  to  an  equivalent  amount. 

22.  The  exporter,  or  if  he  has  pledged  the  bonds  the  in- 
stitution with  which  he  has  repledged  them  acting  on  his 
behalf,  would  be  free,  in  the  event  of  the  importer  not  ful- 
filling the  term's  of  his  contract,,  to  hold  until  maturity 
the  bonds  given  as  collateral  by  the  importer,  or  to  sell 
them  in  accordance  with  the  custom  in  his  country  in 
case  of  default. 

23 .  In  the  second  alternative  an  option  of  repurchasing 
the  bonds  direct  must  first  be  given  for  a  short  period  to 
the  Government  which  issued  them. 

24.  If  a  sale  is  resorted  to  and  results  in  a  surplus  be- 
yond what  is  necessary  to  cover  the  claims  of  the  exporter 
upon  the  importer,  the  exporter  shall  be  held  accountable 
for  that  surplus  to  the  Government  which  issues  the  bonds. 


BRUSSELS  CONFERENCE  259 

25.  The  revenues  from  the  assigned  assets  shall  be 
applied  as  follows  to  the  service  of  the  bonds. 

26.  Out  of  these  revenues,  the  commission  or  the  par- 
ticipating Government,  as  the  case  may  be,  shall  pur- 
chase foreign  currencies  sufficient  to  meet  at  their  due 
date  the  coupons  on  all  bonds  any  time  outstanding  in  the 
different  foreign  currencies. 

27.  In  addition  they  shall  establish  abroad  in  the  ap- 
propriate currencies  a  sinking  fund  calculated  to  redeem  at 
maturity  10  per  cent  of  the  bonds  outstanding  in  each  of 
the  different  countries . 

28.  Further,  in  addition  to  the  amounts  provided  for 
payment  of  coupons  and  for  the  endowment  of  the  sinking 
fund,  they  shall  establish  out  of  the  assigned  revenues  a 
special  reserve  in  one  or  more  foreign  currencies  for  the  re- 
demption of  bonds  sold  in  accordance  with  par.  22. 

29.  The  amount  to  be  set  aside  for  the  special  reserve 
shall  in  each  case  be  determined  by  the  commission. 

30 .  Any  surplus  remaining  at  the  end  of  each  year  after 
the  provision  of  these  services  shall  be  at  the  free  disposal 
of  the  participating  Government. 

31.  A  participating  Government  shall  have  the  right  to 
offer  its  o^^'n  bonds  as  collateral  for  credits  obtained  for  the 
purpose  of  importations  on  Government  account.  The 
previous  assent  of  the  commission  will  in  these  cases  also 
be  required  for  the  particular  importations  desired  by  the 
participating  Government. 

32.  If  a  participating  Government  which  has  been  in 
control  of  its  assigned  revenues  should  fail  to  fulfil  its 
obligations,  the  exporter  concerned  will  notify  the  com- 
mission and  the  commission  will  apply  to  the  Council  of 
the  League  of  Nations  for  the  transfer  of  the  manage- 
ment of  the  assigned  revenues  to  the  commission . 

33.  The  consent  of  the  commission  is  necessary  when- 
ever bonds  secured  on  the  assigned  assets  are  given  as 
collateral  and  shall  as  a  rule  be  accorded  only  for  the  im- 
port of  raw  materials  and  primary  necessities . 

34.  The  commission  may,  however,  at  its  discretion. 


260  INTERNATIONAL  EXCHANGE 

sanction  in  advance  the  importation  of  specified  quantities 
of  such  goods. 

35.  Even  in  the  case  of  imports  under  such  a  general 
sanction  a  notification  of  the  particular  transaction  must 
be  registered  with  the  commission. 

36.  The  assent  of  the  commission  must  also  be  obtained 
in  every  case  to  the  term  of  the  credit  which  it  is  proposed 
to  open. 


APPEXDIX  B 
DOMESTIC  EXCHAXGE 

Before  the  development  of  the  Federal  Reserve 
System,  the  busmess  men  of  the  United  States  were 
familiar  with  domestic  exchange  which  expressed  it- 
self in  the  form  of  premiums  on  Xew  York  drafts, 
collection  charges  for  out-of-town  checks  and  in  other 
ways. 

The  situation  which  existed  a  few  years  ago  is 
described  by  Dean  Joseph  French  Johnson  in  his 
"Money  and  Currency,"  as  follows: 

Payments  between  different  communities  of  the  same 
country  may  be  effected  by  the  shipment  of  currency  or 
by  the  use  of  credit.  In  the  United  States  some  form  of 
credit  is  usually  employed,  shipments  of  currency  being 
made  only  when  the  people  of  a  community  as  a  result 
of  their  business  transactions  are  called  upon  to  make 
payments  to  outsiders  in  excess  of  the  payments  due  to 
them.  Every  bank  in  the  United  States  has  funds  on 
deposit  in  one  or  more  banks  in  other  communities,  and 
thus  is  able  to  sell  to  its  customers  drafts  calling  for  the 
payment  of  money  in  other  cities.  Every  bank  in  the 
United  States  can  sell  a  draft  on  New  York  or  even  on 
London.  All  country  banks  do  not  maintain  deposit 
accounts  in  New  York  City,  but  have  deposit  accounts 
with  banks  in  near-by  large  cities,  and  these  have  balances 

261 


262  INTERNATIONAL  EXCHANGE 

in  New  York  upon  which  their  country  correspondents^ 
are  permitted  to  draw. 

For  example,  a  bank  in  Barre,  Massachusetts,  need 
maintain  no  deposit  account  in  New  York  in  order  to  sell 
a  draft  on  New  York,  a  credit  balance  in  some  Boston 
bank  being  all  that  is  necessary.  WTien  one  of  its  cus- 
tomers desires  a  draft  on  New  York  the  Barre  bank  may 
issue  it  to  him  upon  a  blank  furnished  by  its  Boston  cor- 
respondent. The  Barre  bank  immediately  notifies  the 
Boston  bank  of  the  transaction.  The  latter  debits  the 
Barre  bank  with  the  face  of  the  draft,  and  advises  its 
New  York  correspondent  that  such  a  draft  has  been  drawn 
at  Barre;  and  the  New  York  bank,  when  it  honors  or  pays 
the  draft,  debits  its  face  to  the  Boston  bank.  In  this 
simple  way  the  banks  of  the  country  are  all  linked  to- 
gether. Small  banks  in  the  neighborhood  of  New  Orleans, 
for  example,  sell  exchange  upon  New  York  through  their 
relations  with  the  New  Orleans  banks.  In  the  same  way 
small  banks  in  the  neighborhood  of  St.  Paul  have  power 
to  sell  exchange  upon  New  York  or  upon  Chicago  through 
their  relation  with  the  banks  of  St.  Paul.  Thus  the  coun- 
try is  made  up  of  small  financial  circles  and  centers,  all 
included  within  a  great  circle  of  which  New  York  is  the 
grand  center. 

The  medium  most  employed  for  the  payment  of  debts 
between  different  communities  is  New  York  exchange. 
By  this  is  meant  a  draft,  or  other  credit  instrument  pay- 
able in  New  York  City.  The  acceptability  of  New  York 
exchange  thruout  the  country  is  due  primarily  to  the 
fact  that  New  York  is  the  commercial  center  of  the 
country .  Tradesmen  everywhere  have  dealings  with  New 

1  "Correspondent"  is  the  technical  term  employed  by  banks  to  desig- 
nate those  banks  with  whom  they  maintain  deposit  accounts  or  for  whom 
they  carry  deposits.  Thus  the  First  National  of  St.  Louis  and  the  Sixth 
National  of  New  York  may  be  correspondents,  the  St.  Louis  bank  main- 
taining a  deposit  account  in  the  New  York  bank.  The  New  York  bank 
has  no  need  for  a  deposit  balance  in  St.  Louis,  but  makes  use  of  the 
services  of  its  St.  Louis  correspondent  for  the  collection  of  checks  upon 
banks  in  St.  Louis  or  its  aeighborhood. 


DOMESTIC  EXCHANGE  263 

York  City.  There  is  not  a  store  in  the  country  which  does 
not  receive  either  directly  or  indirectly  certain  of  its  sup- 
plies from  that  city.  The  greater  portion  of  the  surplus 
products  of  the  country  each  year  passes  thru  the 
port  of  New  York  on  its  way  to  Europe.  The  manu- 
facturers of  New  York  are  the  largest  customers  of  the 
producers  of  raw  materials. 

Thus  it  happens  that  every  part  of  the  country  con- 
tains men  who  are  selling  goods  to  New  York,  and  also 
men  who  are  buying  goods  from  there.  If  all  pa^Tnents 
were  made  with  money,  the  one  class  would  be  receiving 
sums  of  money  from  New  York  while  the  other  class  would 
be  shipping  sums  of  money  to  New  York.  By  the  use  of 
credit  the  shipment  of  money  is  almost  entirely  dispensed 
with.  "When  a  southern  cotton  factor,  for  example,  ships 
cotton  to  New  York  he  may  receive  payment  in  a  check 
on  a  New  York  bank.  This  he  deposits  in  his  local  bank, 
receiving  credit  therefor  as  if  he  had  deposited  money. 
On  the  other  hand  when  a  southern  merchant  receives 
goods  from  New  York  he  buys  from  his  local  bank  a  draft 
on  that  city  and  with  it  satisfies  the  claim  of  his  New 
York  creditor.  In  neither  case  is  the  shipment  of  money 
or  currency  necessary. 

How  the  local  banks  get  their  power  to  sell  drafts  on 
New  York  can  best  be  shown  by  a  concrete  illustration. 
We  will  suppose  that  a  bank  in  Aurora,  Illinois,  has  on 
deposit  $10,000  with  the  First  National  of  Chicago.  Let 
us  suppose  that  an  Aurora  manufacturer  has  sold  stoves 
to  an  eastern  dealer  and  has  received  in  pa\TQent  a  check 
for  $1000  on  the  Corn  Exchange  bank  of  New  York.  He 
will  deposit  this  check  in  his  Aurora  bank,  which  will 
send  it  to  its  Chicago  correspondent,  and  thereby  increase 
its  credit  balance  to  $11,000.  The  Chicago  bank  will 
send  the  check  to  its  correspondent  in  New  York,  and  so 
increase  its  credit  balance  in  New  York  by  $1000.  By  an 
arrangement  with  the  First  National  of  Chicago  the  Aurora 
bank  is  able  to  sell  drafts  on  the  Corn  Exchange  of  New 
York,  using  for  the  purpose  blank  drafts  furnished  by  the 


264  INTERNATIONAL  EXCHANGE 

First  National.  It  is  quite  possible  that  on  the  same  day 
a  merchant  in  Aurora,  who  has  bought  goods  from  New 
York,  will  call  upon  the  Aurora  bank  for  a  draft  on  New 
York.  He  may  not  want  a  draft  for  exactly  $1000,  but 
that  does  not  matter.  The  Aurora  bank  is  able  to  sell 
to  him  a  draft  for  any  amount  up  to  $11,000,  for  its 
credit  balance  in  the  Chicago  bank  gives  it  a  right  to 
"draw"  upon  New  York  for  that  amount.  Thus,  on  ac- 
count of  New  York's  trade  relations  with  all  parts  of  the 
country,  banks  everywhere  are  usually  able  to  sell  drafts 
on  that  city  without  being  compelled  to  ship  currency. 

New  York  exchange  is  used  not  only  for  pa;>Tnents  be- 
tween New  York  and  other  parts  of  the  country,  but  also 
for  payments  between  points  in  the  United  States  outside 
of  New  York.  A  man  living  in  Buffalo  who  owes  $1000 
to  a  man  in  New  Orleans  can  best  pay  the  debt  by  remit- 
ting a  draft  on  New  York  City.  This  method  is  the  one 
usually  employed,  for  Buffalo  banks  maintain  no  balances 
in  New  Orleans,  and  so  cannot  sell  drafts  on  that  city. 
They  can,  however,  sell  a  draft  on  New  York,  and  that 
will  usually  be  accepted  by  New  Orleans  banks  at  par. 
When  the  reader  takes  into  account  that  New  York  checks 
and  drafts  are  every  day  being  used  in  this  way  for  the 
cancellation  of  debts  in  all  parts  of  the  United  States,  he 
will  understand  why  New  York  exchange  is  deservedly 
called  "the  business  man's  money." 

CAUSES    OF   CURRENCY    SHIPMENTS. 

But  does  not  a  bank  sometimes  receive  a  call  for  more 
New  York  exchange  than  it  can  conveniently  sell?  This 
does  frequently  happen,  and  as  a  result  bankers  are  some- 
times forced  to  charge  a  small  premium  for  New  York 
exchange.  The  price  which  they  can  charge  is  definitely 
fixed  by  the  cost  of  shipping  currency.  This  cost  depends 
upon  three  items:  first,  the  express  charge;  second,  in- 
surance; third,  the  loss  of  interest.  As  a  rule,  the  first 
two  charges  are  linked  together  in  a  charge  made  by  the 
express  company,  on  account  of  its  guaranty  to  deliver 


DOMESTIC  EXCHANGE  ^65 

the  currency  to  the  consignee.  The  third  item  of  cost 
varies  with  the  rate  of  interest.  The  moment  a  bank  gives 
money  to  an  express  company  for  shipment  to  New  York 
City,  the  bank's  power  to  use  it  as  a  reserve,  or  basis  for 
loans,  has  gone.  That  money  cannot  again  become  the 
basis  for  banking  transactions  until  it  has  reached  New 
York.  The  amount  of  this  item  is  high  or  low  according 
to  the  rate  of  interest  at  the  point  from  which  the  ship- 
ment is  made.  These  three  items  amount  to  about  50 
cents  per  $1000  on  a  shipment  of  currency  between  New 
York  City  and  Chicago.  Hence  Chicago  bankers  are  not 
able  to  charge  more  than  50  cents  premium  on  a  New 
York  draft  for  $1000.  A  man  who  wishes  to  send  $1000 
to  New  York  will  not  pay  a  bank  over  $1000.50  for  a 
draft,  for  at  that  price  he  can  ship  the  currency  by  express. 
The  shipment  of  currency  from  one  point  to  another 
and  the  fixing  of  the  rate  of  exchange  are  matters  attended 
to  by  the  banks  themselves.  No  private  business  man — 
excepting  perhaps  a  few  whose  transactions  foot  up  large 
totals — ever  thinks  of  shipping  currency  from  one  point 
to  another.  If  the  people  of  a  western  city  have  been 
buying  from  the  East  more  largely  than  they  have  sold 
to  it,  so  that  their  calls  upon  the  local  banks  for  New 
York  exchange  exceed  the  incoming  supply,  the  banks 
themselves  are  forced  to  ship  currency  to  New  York  in 
order  to  cover  their  sales  of  exchange.  In  the  large  cities 
the  banks  make  a  business  of  buying  and  selling  exchange 
from  one  another.  When  the  First  National  of  Chicago 
for  example,  finds  that  its  New  York  balance  is  running 
low  on  account  of  the  demand  by  its  customers  for  New 
York  drafts,  it  endeavors  to  buy  exchange  from  other 
banks  in  Chicago,  and  will  pay  them  a  premium  for  it. 
In  no  case,  however,  will  it  pay  more  than  50  cents  per 
$1000.  The  sellers  will  be  banks  which  find  that  they 
have  on  hand  more  exchange  on  New  York  than  they 
have  need  for,  and  they  will  ask  for  this  exchange  as  high 
a  premium  under  50  cents  per  $1000  as  they  can  obtain. 
The  height  of  the  premium  is  fixed  by  competition  between 


'^m  INTERNATIONAL  EXCHANGE 

buying  and  selling  banks.  Sometimes  the  supply  of 
New  York  exchange  will  be  so  great  that  it  will  be  sold 
by  one  bank  to  another  at  a  discount.  If  a  bank  having  a 
large  credit  in  New  York  City  orders  currency  shipped 
to  it,  the  expense  on  each  thousand  dollars  will  be  50 
cents.  The  bank  can  better  afford  to  sell  drafts  on  New 
York  to  its  neighborhood  at  a  discount  of  40  cents  per 
$1000  than  order  the  shipment  made. 

In  the  long  run  the  supply  of  New  York  exchange  in 
any  community  is  about  equal  to  the  demand  for  it .  This 
is  another  way  of  saying  that  each  community  in  the  long 
run  sells  to  other  communities  as  much  as  it  buys  from 
them.  In  certain  seasons  of  the  year,  however,  agricul- 
tural districts  buy  much  more  from  the  East  than  they 
sell  to  it.  This  is  always  the  case  in  the  winter  and  spring. 
No  crops  are  then  being  harvested,  yet  merchants  all  over 
the  country  are  laying  in  their  stock  of  spring  and  summer 
goods.  As  a  result  there  is  so  strong  a  demand  thru- 
out  the  country  for  drafts  on  New  York  that  country 
banks  are  generally  obliged  to  make  some  shipment  of 
currency  to  New  York  in  order  to  cover  the  drafts  they 
sell.  The  opposite  condition  prevails  in  the  fall  when  the 
crops  are  marketed  and  are  going  forward  for  export. 
Then  the  farmers  of  the  West  and  planters  of  the  South 
are  receiving  in  payment  for  their  goods  eastern  checks, 
which  they  deposit  in  local  banks.  Country  banks  now 
find  their  balances  piling  up  in  New  York  and  are  unable 
to  sell  New  York  exchange  as  fast  as  they  would  like. 
As  a  result  New  York  City  banks  are  usually  ordered  in 
the  fall  to  make  shipments  of  cash  to  the  West.  In  the 
winter  and  spring,  when  the  West  is  a  heavy  buyer  from 
the  East,  New  York  exchange  is  usually  quoted  at  a 
premium  in  western  cities.  In  the  autumn  it  is  usually  at 
a  discount,  all  banks  having  an  excessive  supply. 

There  is  another  reason  for  this  seasonal  movement  of 
currency  between  New  York  and  the  country  districts. 
In  the  autumn,  when  the  crops  are  harvested,  there  is  a 
great  increase  thruout  the  West   and  the  South  in  the 


DOMESTIC  EXCHANGE  267 

need  for  "hand-to-hand  money."  This  must  be  furnished 
by  the  country  banks,  and  they  are  forced  to  draw  on  their 
New  York  balances,  first  by  sales  of  New  York  exchange 
and  finally  by  ordering  the  cash  shipped  to  them.  In 
the  winter  and  spring  cash  flows  back  into  the  country 
banks,  until  they  have  more  than  they  can  profitably 
use.  Then  they  build  up  their  New  York  balances  either 
by  buying  and  remitting  exchange  or  by  shipping  currency. 

^Miat  is  to  prevent  a  community  from  sometimes  buy- 
ing much  more  from  New  York  than  it  sells  to  that  city? 
Indeed,  is  not  any  communit}^  always  in  danger  of  pur- 
chasing so  much  from  other  parts  of  the  country  that  its 
bankers  may  be  obliged  to  send  out  all  their  supply  of 
currency  in  order  to  make  the  payments.^  This  brings 
up  the  question  of  the  balance  of  trade  between  communi- 
ties. The  balance  of  trade  is  usually  discussed  by  econo- 
mists only  in  relation  to  trade  between  different  countries 
yet  the  principles  governing  such  trade  differ  in  no  respect 
from  those  governing  trade  between  communities  within 
the  same  country. 

There  is  never  any  danger  that  a  community  will  be 
stripped  of  its  money  or  cash  as  a  result  of  its  purchase  of 
goods  from  other  communities.  No  matter  how  freely 
Chicago  and  the  country  tributary  to  it  may  purchase 
goods  from  the  East,  those  purchases  can  never  make  any 
serious  drain  upon  the  cash  supply  of  Chicago.  No 
matter  how  extravagant  the  people  of  the  West  may  be, 
their  purchases  of  eastern  goods  can  never  be  greatly  in 
excess  of  their  sales  to  eastern  consumers.  Should  the 
people  of  Chicago  for  extraordinary  reasons  at  any  time 
increase  their  purchases  from  New  York  and  other  eastern 
cities,  the  first  effect  in  Chicago  would  be  an  increase  in 
the  demand  for  New  York  exchange  and  in  bank  shipments 
of  currency  from  Chicago  to  New  York.  The  loss  of 
currency  in  Chicago,  since  it  would  reduce  the  lending 
power  of  Chicago  banks,  would  tend  to  cause  a  rise  in  the 
rate  of  interest  and  a  rise  in  the  value  of  money.  The 
prices  of  commodities  named  would  begin  to  decline;  not 


268  INTERNATIONAL  EXCHANGE 

of  all  commodities,  but  of  those  which  are  subjects  of 
speculation,  such  as  stocks,  wheat,  corn,  and  pork.  Most 
of  the  speculators  in  these  articles  are  borrowers,  and 
the  interest  they  pay  is  an  important  item  in  the  expenses 
of  their  business,  so  that  when  the  interest  rate  rises  they 
are  obliged  to  contract  their  operations.  Chicago  would 
thus  become  a  good  place  to  lend  in  and  also  a  good  place 
in  w^hich  to  buy  stocks  and  bonds,  wheat,  and  other 
speculative  commodities.  In  other  words,  the  value  of 
money  would  rise  in  Chicago,  and  people  in  other  parts 
of  the  country  w^ould  increase  their  purchases  in  Chicago 
markets,  remitting  New  York  exchange  in  payment. 
The  reader  must  not  suppose  that  these  changes  in  price 
or  in  the  rate  of  interest  need  be  so  great  as  to  attract 
general  attention.  Nevertheless  it  cannot  be  doubted 
that  such  changes  do  take  place,  and  that  as  a  result  the 
sales  of  Chicago  to  other  parts  of  the  country  are  so  ad- 
justed that  in  the  long  run  they  furnish  a  supply  of  New 
York  exchange  equal  to  the  demand. 

Thus  it  happens  thruout  the  country  that  in  the 
course  of  a  year  the  debts  of  every  community  are  always 
practically  balanced  by  its  credits  on  account  of  sales,  so 
that  large  shipments  of  currency  are  never  necessary. 
Indeed,  if  our  monetary  banking  systems  were  perfect, 
no  shipment  of  currency  from  one  part  of  the  country  to 
another  w^ould  ever  occur  as  a  necessity  result  of  trade 
transactions.  Money  or  currency  would  only  be  shipped 
to  a  community  as  a  result  of  an  increasing  need  for  it  as  a 
medium  of  exchange  or  as  a  basis  for  the  expansion  of 
bank  credits.  In  Canada,  for  example,  on  account  of  the 
elasticity  of  its  bank-note  circulation,  seasonal  variations 
in  the  demand  for  currency  are  easily  provided  for  by  the 
local  banks  and  their  branches. 

The  tendency  of  commercial  nations  is  to  reduce 
premiums  and  discount  upon  domestic  exchange  to 
the  minimum.  This  is  effected  in  the  first  instance 
by  the  concentration  of  the  business  in  the  larger 


I^OMESTIC  EXCHANGE  269 

banks.  The  fewer  the  persons  concerned  the  less  the 
likehhood  that  any  currency  shipments  will  be  re- 
quired and  hence  the  fundamental  condition  which 
causes  payments  at  distant  points  to  be  more  expen- 
sive than  local  payments  disappears. 

The  demand  for  payments  between  communities  is 
then  a  fluctuating  one,  now  inclining  in  one  direction, 
now  in  the  other.  If  we  conceive  that  all  these  trans- 
actions were  effected  thru  a  single  bank  with  large 
capital  and  with  branches  in  different  places,  adjust- 
ments could  be  made  Vvdth  the  minimum  difficulty. 
To  the  bank  it  would  mean  in  the  main  a  different 
drain  on  the  resom'ces  of  the  different  branches  at 
different  times  which  in  the  long  run  would  equalize 
one  another.  Under  these  circumstances  the  bank,  in 
order  to  facilitate  to  the  utmost  exchanges  between 
all  parts  of  the  country,  might  very  well  agree  to  ac- 
cept all  payments  at  face  value  charging  no  premium 
therefor  and  allowing  no  discount. 

This  is  in  effect  what  has  taken  place  in  the  United 
States  thru  the  action  of  the  Federal  Reserve  banks. 
Domestic  exchange  has  disappeared  as  a  charge  on  the 
mercantile  community,  and  for  the  purpose  of  making 
payments  the  whole  United  States  has  become  a 
single  banking  unit. 

That  does  not  mean  that  as  a  theoretical  possibility 
there  is  no  longer  such  a  thing  as  domestic  exchange. 
It  simply  means  that  its  charges  have  been  absorbed 
into  the  operating  expenses  of  the  Federal  Reserve 
Banking  system  and  are  no  longer  charged  to  the 


270  IXTERXATIOXAL  EXCHANGE 

customer.  The  case  is  analogous  to  your  relations 
to  your  bank  of  deposit.  Whenever  the  bank  collects 
for  you  thru  the  Clearing  House  a  check  on  another 
bank  it  incurs  an  expense,  whenever  it  cashes  your 
check  it  incurs  an  expense.  But  these  expenses  are 
not  charged  to  you.  The  bank's  operations  do  not 
appear  as  charges  in  your  account,  tho  if  the  bank 
analyzes  the  latter,  they  are  an  important  element  in 
determining  whether  your  account  is  profitable  to 
the  bank. 


INDEX 


Arbitrage, 

See  Investment  and  Arbitrage 
Australia, 

London  Exchange  -with,  61 

Bank  Rate, 

Bank   of   England   fixes,    v^O;    In   New 
York,  121 
Bank  of  England  Bate, 

Importance  of.  122;  Minimum  discounts, 
123;  Margraff  on,  12-i 
Bankers'  Long  Bills, 

Form  of  draft,  96;  Rates  of  interest,  119 
See  also  Long  Exchange 
Bills  of  Exchange,  127-146 

Purpose,  127;  Sight  drafts,  128;  Cable 
transfer,  132;  Unusual  rates,  133; 
Long  exchange,  134;  Influence  of  in- 
terest rate,  136;  Commercial  and  bank- 
ers' bills,  138;  Bills  involving  risk, 
139;  Letters  of  credit,  141 
Bi-metallism, 

No  longer  an  issue,  175;  Fixed  approx- 
imate par,  177 
Brussels  Conference  1920,  241,  246 
Resolutions  of,  247-260 

Cables, 

Identity  ^\-ith  checks,  132;  Rates  at  open- 
ing of  war,  133;  MargraS's  summary, 
133 
Canada, 

Exchange  transaction  with  New  York, 
12;  Status  of  exchange,  24;  Discounts 
and  premiums,  61 ;  Foreign  remittances 
147;  Silver  melting  points,  196 
Cannan,  Edwin, 

On  depreciation  of  European  currencies, 
197 
Cassel,  Gustav, 

On  depreciation,  235 
Ceylon,  Transaction  with,  79 
Chain  Rule  Exchange  Calculation,  100 
Check,  Travelers,  153 
Chili,  Monetary  Situation,  207 
China, 

Silver    standard,    175;    Currency,    193; 
Exchange  on,  195 
Circular  Nctes,  Form  of  remittance,  168 
Civilization,  and  Exchange,  1 
Clare,  George, 

On  finance  bills,  109 


Commercial  Long  Bills, 

L'se  in  export  trade,  66;  On  foreign  debt- 
ors, 135;  Payment  bills,  138;  Accept- 
ance bills,  139 
Credit, 

Letters  of.  Commercial,  141;  Traveler's, 
160 
Credits,  Foreign,  present  diflBcuIties,  242 
Currency  Shipments, 
Causes  of,  264 


Depreciation  of  currencies,  225,  235 
Discount  on  Exchange, 

Cause  of,  15;  How  expressed,  61 
Discount  Market, 

Liquid,  216;  London's,  223 
Documentary   Bills, 

Protection  of  buyer,  138 
Dollar  Acceptances, 

National  Bank  Act  Prohibits,  71;  Jacobs 
on,  72;  Federal  Reserve  Act  permits, 
74 
Dollar  Credits, 

Financing  Exports,  60;  Imports,  84 
Domestic  Exchange,  261 

Exchange  between  American  cities  de- 
scribed, 261;  Causes  of  Currency  ship- 
ments,   264;    Federal    Reserve    Bank 
absorbs  exchange  charges,  269 
Drafts, 

Issue  of,  148;  Advices,  150;  Specimen, 
forms  and  signatures,  152;  Cost  of 
drafts,  153 


Edge  Act,  228,  244 
Escher,  Franklin, 

Defines    Finance  Bills,  109;  On  dealing 
in  futures,  116 
Exchange,  Fundamentals  of,  12-26 

Clearing  processes,  12;  Settling  equal  and 
unequal  debts,  12;  Dealer  in  exchange, 
13;  Rates,  14;  Discounts,  15;  Exchange 
market,  16;  Exchange  centers,  17;  De- 
mand and  supply,  IS;  Exchange,  a 
trade  factor,  19;  Role  of  money,  21; 
Foreign  exchange,  22;  Similarity  and 
differences  in  money  used,  23;  Dif- 
ferent coinage,  25;  Different  standards, 
26 

See  also  Restoration  Prospects  for 


271 


272 


INDEX 


Exchange  Quotations, 

American  method,  57;  Range,  58;  Fixed 
and  movable  exchange,  59;  Premium 
and  Discount,  61 
Exchange  Tables, 

Use  of,  62 
Exports,  Related  to  Imports,  28 

Visible  and  invisible,  29 
Exports  and  Imports,  65-89 

Payments  for  Exports,  65;  Plan  of  trans- 
action, 67;  Dollar  credits,  69;  Dollar 
acceptances,  71;  Export  letters  of 
credit,  75;  Letters  of  credit  and  import- 
ing, 77;  British  acceptances,  78; 
Draft  in  London,  80;  London's  part, 
82;  Dollar  exchange,  84;  Exports  and 
imports,  complementary,  85 


Federal  Reserve  Act 

Permits  bank  acceptances,  74 
Federal  Reserve  Banks, 

Eliminate  domestic  exchange,  269 
Fiat  Money, 

See  Paper  Money 
Finance  Bills,  33,  108-118 

Definition,  108;  For  New  York  accounts, 
109;  Methods  of  using,  110;  Loan  of, 
112;  On  London  account,  113;  Other 
uses  of,  114;  Forward  exchange,  115 
Financial  Centers,  New  York  and  Lon- 
don, as,  212-224 

New  York's  prominence,  212;  What 
makes  a  financial  center,  212;  Finance 
follows  flag,  213;  World  exchange  re- 
quires gold,  215;  Liquid  discount 
market,  216;  New  York's  advantages, 
217;  London's  physical  advantages, 
219;  Mail  and  Cable  facilities,  220; 
Time  advantages,  220;  Natural  char- 
acteristics, 221;  Seeking  fortune 
abroad,  222;  London's  discoxint  mar- 
ket, 223 
Fixed  Exchange,  59 
Foreign  Money  Orders, 

Issued  by  banks,   168;  Payments,  171; 
Redemption,  172 
Foreign  Remittances,  147-174 

Non-commercial  exchange,  147;  Drafts, 
148;  Advices,  150;  Specimen  forms, 
152;  Cost  of  drafts,  152;  Traveler's 
checks,  153;  Payment  of  checks,  154; 
Payment  to  holders,  154;  Redemption 
of  checks,  157;  Letter  of  Indication, 
158;  Lost  checks,  159;  Letters  of 
credit,  160;  Forms,  162;  Payment  to 
holder,  167;  Circular  notes,  168; 
Foreign  money  orders,  168;  Mail  re- 
mittances, 172 


Forward  Exchange, 

Relation  to  finance  bills,  115;  Bank  meth- 
ods  to  protect,  115;  Escher  on  dealing 
in  futures,  116 
Freight  Payments  and  Exchange,  37 
Futures 
See  Forward  Exchange 

Qeorge,  Lloyd, 

British  credits  before  the  war,  82 

Gold  Exchange  Standard,  40 

Gold  Exchange  Rates,  39-64 

Gold  standard,  39;  Gold  exchange  stand- 
ard, 40;  Monetary  systems,  40;  Mint 
par,  42;  Exchange  par,  44;  Rates,  45; 
How  fixed,  46;  Coinage  ratio,  47; 
Fluctuations  of  exchange  rate,  47;  Gold 
points,  49;  Meaning  of  gold  shipments, 
51;  Actual  gold  oints,  51;  Computing 
gold  points,  52;  Gold  shipments,  63; 
Avoiding  shipments,  55;  Reading  Ex- 
change rates,  55;  Quotations,  56; 
Range,  58;  Fixed  and  movable  ex- 
change, 59;  Premium  and  discount, 
61;  Exchange  tables,  63 

Gold  Points, 

Limits  to  exchange,  49;  Significance  of 
gold  movements,  51;  Computing  gold 
points,  52;  Gold  shipments,  54;  Avoid- 
ing gold  shipments,  55 

Gold  Standard,  9,  39 

Honduras,  transaction  with,  75 

Imports, 

See  Exports  and  Imports, 

India, 

Demand  for  silver,  179,  184;  Effect  on 
exchanges,  182 

Indication,  Letter  of,  158 

Inflation  of  Modem  Currencies,  225,230 

Interest,  EfiEect  on  Long  Bills,  136 
See  Rates  of  Interest 

International  Payments,  27-38 

Causes  of,  27;  Relation  of  exports  and 
imports,  28;  Supply  of  exchange,  30; 
Avoiding  gold  shipments,  32;  United 
States  in  account  with  world,  33;  Ele- 
ments in  the  account,  36 

International  Investments,  238 

Investments,  33 

Investment  and  Arbitrage,  90-107 

International  finance,  90;  Investments, 
90;  Foreign  investments  in  United 
States,  93;  United  States  a  creditor 
nation,  95;  International  securities, 
95;  What  is  arbitrage,  96;  When  tran- 
sacted, 96;  Parity  in,  97;  Chain  rule, 
100;  Simple,  101;  Compound,  103; 
Calculation,  104;  In  gold,  105 


INDEX 


273 


Invisible  Exports,  and  Imports,  29 
Irredeemable  Paper  Money, 
See  Paper  Money 

Jacobs,  L.  M., 

On  dollar  acceptances  72 
Jevons,  W.  S., 

On  Paper  money,  231 
Johnson,  Joseph  French, 

Statement  of  United  States  in  account 
\\ith  world,  35;  Exports  and  imports 
complementary,  87;  India  and  silver, 
179;  Domestic  exchange,  261 

Letters  of  Credit, 

Commercial,  141;  Traveler's,  160 
London,  compared  with  New  York,   17, 
31,  44,  48,  51,  53,  59,  65,  69,  75,  78, 
82,  84,  96,   109,   112.   115,   119,   122, 
128,  132,  137,  212-224,  227,  237 
See  also  Financial  Centers 
London,  silver  market,  185 
Long  Exchange, 

Interest  rates,  119;  Bankers  long  bills, 
134,  139;  Commercial  long  bills,  135, 
138;  Documentary  bills,  135,  140 

Mail  Remittances, 

Transactions  for,  172 
Margrafif,  A.  W., 

On  influence  of  Bank  of  England  rate, 
124;     Observations    on     cable    rates, 
133;  On  bills  of  exchange,  140 
Melting  points,  for  silver,  189 
Mint  par,  42 
Monetary  Systems,  40 
Money  Standards, 

Fluctuating,  2;  gold,  silver  and  paper,  10 
Montreal, 

Exchange  transactions  with  New  York, 
12 
Moratorium, 

British  credits  and  the  war,  82 
Movable  Exchange, 

Removed  from  French  quotations  in 
New  York,  57;  Contrasted  with  fixed, 
59;  Rule  for  calculating,  60 

New  York, 

Compareid  with  London,  17,  31,  44,  48, 
51,  53,  59,  65,  69,  75,  78,  82,  84,  96, 
109,  112,  115,  119,  122,  128,  132,  137, 
212-224,  227,  237 
See  also  Financial  Centers 
Paish,  Sir  George, 

On  international  investments,  91,  92 
Paper    Money,    Fiat    or    Irredeemable, 
197-211 
Money  and  war,  197;  Trading  on  paper 
xviii— 19 


Paper  Money — continued 

basis,  199;  Gold  standards  abandoned, 
202;  Current  exchange  rates,  203; 
Paper  currencies,  204;  Paper  stand- 
ards, 205;  Results  of  depreciated 
money,  207;  Chile's  monetary  situa- 
tion, 207 

Parity, 

Quotations  for  and  arbitrage,  97;  Stock 
prices,  99;  Chain  rule  calculations, 
100 

Putnam  Act,  186 

Premium  on  Exchange, 

Cause  of,  15;  How  expressed,  61 

Price, 

Of  silver,  187 

Quotations  Exchange,  55 

Rates  of  Exchange,  45 

Rates  of  Interest,  119-126 

Factor  in  exchange  quotation,  119; 
Long  bills,  119;  Bank  rate,  120;  Mar- 
ket rate,  121;  Retirement  rate,  122; 
Bank  of  England,  122 

Restoration  Prospects  for  Exchange, 
225 
Present  conditions,  225;  New  York  and 
London,  227;  Disorganization,  229; 
Spending  in  excess  of  income,  229; 
Inflation,  230;  Means  of  production 
curtailed,  232;  Working  forces  dis- 
organized, 233;  Commercial  parity, 
234;  Relative  depreciation,  235;  Ex- 
change sensitive,  236;  Financial  re- 
construction, 237;  Exporting  capital, 
238;  Efforts  for  concerted  action,  240; 
International  and  national  issues, 
241;  National  duty,  242;  Difficulty  in 
extending  credits,  242;  Need  of  in- 
creased production,  244 

Retirement  Rate, 
Discounting  Bills,  122 

Securities,  32 
Shipping  Gold,  cost,  53 
Silver  Standard,  175 

Limited  use,  175;  Silver  mint  par,  176; 
No  mint  par  with  gold  countries, 
177;  Exchange  with  gold  countries 
177;  Gold  price  of  silver,  178;  India 
and  silver  money,  179;  Silver  and  ex- 
change, 182;  Asia's  demand  for  silver, 
184;  Market  for  silver,  185;  Price  of 
silver,  187;  Melting  points,  189;  Silver 
coinages,  191;  China's  currency,  193; 
China's  exchange,  195 

Tourists  Expenditure,  37 


274 


INDEX 


Trade, 

Stimvilated   or  depressed  by   exchange, 
19 
Travelers'  Checks, 

Convenience  of,  153;  Payment  methods, 
154;  Specimens,  155,  156;  Redemp- 
tion, 157;  Letter  of  indication,  158; 
Loss  risks,  159 

United   States   in   Account   with   the 
World, 

Foreign  exchange  statement,  35;  Visible 
and  invisible  elements,  36;  Tourist 
expenditxixes,  37;  Ocean  freights,  37 


Visible  Exports  and  Imports,  29 

War,  The  Great, 

Effect  on  exchange,  i;  Causes  fluctua- 
ting money  standards,  3,  6;  Other 
internal  changes,  5;  Trade  currents 
affected,  7;  Normal  exchange  dis- 
turbed, 8 

See   also   Restoration   Prospects   for 
Exchange 
Whitaker,  A.  C, 

On  importance  of  discount  market,  85 


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